Market waits for Fed to tighten despite lack of inflation evidence.

U.S. interest rate policy moves to center stage this week as the Federal Open Market Committee meets to decide whether another round of tightening is in order.

Bond investors generally expect the central bank's policymaking arm to boost both the federal funds and discount rates tomorrow in a move to rein in economic growth and avoid inflation down the road.

While fixed-income market players normally loathe any attempt to raise interest rates, many see the next round of tightening by the Fed as a necessary evil to maintain stability in the economy and the financial markets.

In fact, failure by the central bank to boost rates would probably be a negative for investors because it would toss and element of uncertainty into the bond market and fuel speculation that the Fed is behind the curve on its need to rein in growth.

"The Fed has the perfect opportunity to reduce inflationary expectations, and the market has fully priced in a move," said Donald Fine, chief market analyst at Chase Securities Inc.

On the off chance that the Fed does not move to tighten credit tomorrow, analysts believe the fixed-income market would react negatively and that long-term rates would move higher.

"I don't think the market would be psychologically prepared if the Fed were to leave rates unchanged. I think we'd see a very negative reaction," Fine said.

Because the Fed left rates unchanged last week, market observers believe the next tightening will probably come after tomorrow's meeting of the FOMC.

Most analysts said the odds favor a more aggressive 50-basis-point hike in the federal funds target, rather than the 25-basis-point increments that policymakers made in three tightening moves earlier this year The discount rate is expected to rise 3.5% or even to 4% they said.

Proponents of a 50-basis-point hike in the federal funds rate say the economy is growing too strongly to keep inflation under wraps, and the financial markets need a large move to settle them. Supporters of a smaller move say growth is set to weaken from here, and the Fed is typically cautious about moving too swiftly.

Once the Fed gets the next tightening move out of the way, bond investors will begin to look forward to the next round of rate hikes.

"Whether or not he Fed will raise rates further in the future will depend on the strength of he economic expansion during the current quarter and the second half of the year," said Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp.

Treasury Market Friday

News that consumer prices rose less than expected in April propelled the Treasury market higher Friday.

The 30-year bond ended Friday's session up 5/8 of a point, to yield 7.49%.

The Labor Department reported that consumer prices rose 0.1% in April, and 0.2% excluding food and energy prices. The numbers were below the average estimates of most economists, who generally expected a 0.2% to 0.3% gain in the CPI both with the without food and energy prices.

Government securities prices surged immediately following the report, but the gains were met with profit taking and the market gradually returned to opening levels.

Now that fixed-income market players have seen the April PPI AND CPI reports, most are concluding that price pressures in the economy remain moderate, and that despite broadbased signs of strength in the economy, thrifty consumers are not allowing retailers to pass along price increases.

"Overall, the inflation reports were constructive to the market," a market strategist said. "There was the fear that the strength in the economy would begin resulting in upward price pressure. These reports show that any such pressure is modest."

In futures Friday, the June bond contract ended up 25/32 at 103.04.

In the cash markets, the 5 1/2% two-year note was quoted late Friday up 4/32 at 99.01-99.02 to yield 6.01%. The 6 1/2% five-year note ended up 11/32 at 98.14-98.16 to yield 6.86%. The 5 7/8% 10-year note was up 16/32 at 99.24-99.28 to yield 7.26%, and the 6 1/4% 30-year bond was up 20/32 at 85.07-85.11 to yield 7.49%.

The three-month Treasury bill was down one basis point at 4.20%. The six-month bill was down two basis points at 4.83%, and the year bill was down six basis points at 5.3%.

Corporate Securities

More junk bonds are coming to market with fewer covenants to protect investors, according to a study by Fitch Investors Service Inc.

The conclusion was drawn from a Fitch study of 540 speculative-grade corporate debt issues sold since 1991. Bonds rated BB, considered the best among speculative-grade issues, lack certain elements of the usual protective covenants.

Covenants limit activities of companies that may be detrimental to bondholders. Missing covenants put investors at greater risk.

Given two otherwise similar companies issuing speculative debt, Fitch said a higher rating will be given to bonds that contain better covenants, offer greater asset protection, and provide less volatile cash flow coverage of interest and principal over a spectrum of foreseeable events.

Among the BB issues surveyed, only 54% had changes of control provisions, 56% had debt limitations. and 60% had restricted payment clauses.

The Fitch study concluded that investor seeking higher yields today are settling for less protection than in the past. The study also put forth six key covenants, which when strongly written, protect investors against deterioration of the issuer's cash flow, assets, and capital structure. The covenants place limitations on taking on new debt; securing debt with assets; cash dividends, loans, and other payouts; mergers; asset sales; and change of control provision.

New issues high-yield volume soared to $ 54 billion in 1993 from $10 billion in 1991, as issues rose to 340 from 48, according to Fitch's corporate bond data base. Lower quality B-rated debt amounted to 66% of total offering versus 39% in 1991, indicating a growing potential for defaults. Among the better BB issues, 40% of new offering omitted one or more key covenants. As a result, investors are receiving less than adequate covenant protection than in the past, Fitch said.

In other news, Fitch raised the senior debt of Chrysler Corp. and Chrysler Financial Corp. to A from BBB. Chrysler Financial Corp.'s F-2 commercial paper was affirmed.

The credit trend for both entities is stable, the rating agency said.

The upgrade applies to $2.8 billion of Chrysler's senior debt, including $1.1 billion of Auburn Hills Trust Guaranteed Exchangeable Certificates. Chrysler Financial Corp. has $2.6 billion of outstanding commercial paper and $5.7 billion of long-term debt.

The upgrade follow Chrysler's performance on its commitments to fiscal conservatism and prudent balance sheet management, Fitch said. With these disciplines, supported by an expansion in the North American auto markets, Chrysler has converted product success into a powerful improvement in cash flow and earnings, and substantially improved its profitability and credit protection measurements, Fitch said.

These improving fortunes enabled Chrysler to lower its unfunded pension liability to $2.2 billion at year-end 1993, reduce debt to $2.8 billion, and build cash to $5.9 billion at March 31, 1994. Automotive debt leverage is now 26.6%, and Chrysler's financial flexibility has improved substantially.

In the secondary market for corporate securities Friday, spreads of investment-grade issues narrowed by 1/4 to 1/2 of a point, while high-yield issues generally ended up 1/4 of a point.Treasury Market Yields Prev. Prev. Friday Week Month 3-Month Bill 4.20 4.25 3.666-Month Bill 4.83 4.78 4.121-Year Bill 5.37 5.39 4.692-Year Note 6.01 6.11 5.463-Year Note 6.38 6.43 5.875-Year Note 6.86 6.95 6.487-Year Note 6.93 7.01 6.6010-Year Note 7.27 7.34 6.9430-Year bond 7.49 7.53 7.27Source: Cantor, Fitzgerald/Telerate

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