Renewed strength in the U.S. dollar sparked a dramatic rebound in the Treasury market yesterday as investors prepared for a shift in capital flows in favor of the United States.
The dollar's solid performance helped the government securities market end in positive territory yesterday, rebounding from two consecutive sessions of substantial losses.
The 30-year bond closed up more than 1 1/2 points, to yield 7.49%.
The green-back rallied in overnight trading, supported by expectations for a near-term tightening of monetary policy and the prospect of wider interest rate differentials between the United States and Europe.
The weak dollar has been a persistent problem for fixed-income investors, who worry about the effects of currency volatility on their portfolios.
Investors in dollar-denominated instruments believe that higher U.S. interest rates relative to other industrialized countries will attract capital flows to the Treasury market as yield-hungry investors look for higher rates of return.
"The bond market was clearly chastened by the strong dollar," said William Sullivan, director of financial markets research at Dean Witter Reynolds Inc.
Strong buying by Middle Eastern and Japanese investors as the U.S. dollar rallied in overnight markets boosted Treasuries in early trading. The overseas trading resulted in massive buying in New York as market players covered short positions.
Encouraged by the bond market's solid performance, retail investors stepped up to purchase securities and take advantage of attractive yields brought on by the recent sell-off.
Solid demand for the first of this week's quarterly refunding package lent further support to a market that has sold off sharply in recent sessions on fears that buyers would not bid on the note sales.
"The dollar played a critical role in the better tone of the Treasury market, and that carried over into the auction," Sullivan said.
Late yesterday, the dollar was changing hands at 1.6735 German marks, up from 1.6530 on Monday. The dollar was also quoted at 104.35 yen, up from 102.65 Monday.
The Federal Reserve failed to raise short-term interest rates Tuesday, and the market is now looking ahead to the Treasury's auction of $11 billion of 10-year notes today as part of its quarterly refunding package.
Because the Fed left rates unchanged yesterday, the next tightening will probably come after the May 17 meeting of the Federal Open Market Committee, said Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp.
Schaja, like most market observers, expects the central bank to raise the federal funds rate 50 basis points to 4.25%, along with a 50 basis point increase in the discount rate to 3.50%.
In the meantime, bond investors will cope with supply and two potentially negative inflation reports this week. The quarterly refunding, in particular, will probably preclude the central bank from boosting rates anytime before its policymaking arm meets, analysts said.
The first leg of the refunding produced strong demand as Treasury yields attracted investors who are realizing their appeal relative to certificate of deposit rates. The average yield on the Treasury's $17.10 billion of three-year notes at today's auction was 6.54%.
Helping to fuel debate over future moves by the Fed, a report in the Los Angeles Times said the central bank is poised to boost interest rates even more, taking the federal funds rate to at least 4.5% from the current 3.75% and perhaps as high as 5% over the next several months.
The article attributed the information to interview with unnamed senior Fed officials and depicted a debate taking place within the Fed over the degree of emphasis that should be placed on capacity considerations - such as the unemployment rate and the economy's growth rate -as appropriate triggers for further rate increases.
Inflation hawks are focusing on such considerations, while others, including Fed Chairman Alan Green-span, consider the concept too simplistic, the article said. "So far, they are endorsed only by a minority of the members of the Federal Open Market Committee and do not represent official guidelines for Fed policy-making," the article said.
The targets in question were identified 6.5% and a real gross domestic product growth rate of about 2.5%.
The Labor Department reported Friday that the April unemployment rate was 6.4%, down from 6.5% in March. The first estimate for first-quarter GDP was put at 2.6%.
U.S. central bank officials are convinced that short-term interest rates must go considerably higher now that the recovery is picking up speed and job creation is swelling.
In futures, the June bond contract ended up more than 1 1/2 points at 103.04.
In the cash markets, the 5 1/2% two-year note was quoted late Tuesday up 7/32 at 98.27-98.28 to yield 6.11%. The 6 1/2% five-year note ended up 23/32 at 98.06-98.08 to yield 6.92%. The 5 7/8% 10-year note was up more than a point at 89.31-90.03 to yield 7.31%, and the 6 1/4% 30-year bond was up more than 1 1/4 points at 85.07-85.11 to yield 7.49%.
The three-month Treasury bill was down eight basis points at 4.33%. The six-month bill was down four basis points at 4.93%, and the year bill was down seven basis points at 5.44%.
Corporate Securities
Junk bonds issued by R.H. Macy and Co. improved 1/2 to one point after three different groups submitted revised reorganization plans to a federal mediator.
Macy's, its bondholders committee, and Federated Department Stores said that they had sweetened the terms of their individual plans for Macy's to emerge from chapter 11 bankruptcy.
"The market clearly saw the new plans as good news and pushed priced higher," a trader said.
Macy's 14 1/2% senior subordinated debentures due 1998 surged about one point and were quoted at a bid of 52 1/2, offered at 53 1/2. Macy's 14 1/2% subordinated debentures due 2001 were quoted at a bid of 17 1/2 offer of 19, up about 1/2 a point from Monday's closing level.
In the secondary market for corporate securities, spreads of investment-grade issues narrowed by 1/2 a point, while high-yield issues closed 1/4 to 1/2 a point higher.
In other news, Moody's Investors Service said it confirmed the A1 long-term debt ratings of Bell Atlantic Corp. and its supported non-telephone subsidiaries.
The confirmation reflects the assessment that a material investment by Bell Atlantic in a cable TV company or programming provider is unlikely in the foreseeable future, Moody's said. About 43.7 billion of debt securities is affected.
Moody's said the rating action completes a rating review begun Oct. 11, 1993, concurrent with the company's announcement that it would invest up to $1.04 billion in Iusacell, Mexico's second-largest telecommunications company. The review was expanded two days later when Bell Atlantic announced its intention to merge with Tele-Communications Inc. and Liberty Media Corp.
Debt ratings confirmed at A1 are: Bell Atlantic Corp.'s guaranteed ESOP notes; the medium-term notes of Bell Atlantic Financial Services Inc., Bell Atlantic Systems Leasing International, and Bell Atlantic Tricon Leasing International; and the secured notes of Prefco IX Limited Partnership and BAT Partners L.P., Moody's said.
Bell Atlantic's strategy to take advantage of the accelerating convergence of communications, video entertainment, and information services markets has changed significantly, Moody's said. Treasury Market Yields Prev. Prev. Tuesday Week Month 3-Month Bill 4.33 4.12 3.646-Month Bill 4.93 4.59 4.091-Year Bill 5.44 5.18 4.632-Year Note 6.11 5.83 5.373-Year Note 6.43 6.15 5.795-Year Note 6.92 6.70 6.417-Year Note 6.98 6.76 6.5210-Year Note 7.31 7.11 6.8630-Year Bond 7.49 7.34 7.20Source: Cantor, Fitzgerald/Telerate
