The weak U.S. dollar continued to buck the Treasury market yesterday as investors speculated about the likely effect of its recent declines on Federal Reserve policy.
Government bond prices fell as market players remain fearful that the sliding dollar will force the central bank to raise interest rates sooner than expected.
Compounding the fears was the failure by central banks, through more than a dozen rounds of concerted intervention last week, to shore up the flagging dollar. With intervention looking less and less like a viable method of supporting the dollar, bond market observers are now more inclined to believe that rates are headed up soon.
"Fears over the weak dollar and what the Fed will do about it continue to send the market lower," said Samuel Kahan, chief economist at Fuji Securities Inc. "Clearly the dollar is overshadowing all else."
Late yesterday, the dollar was changing hands at 1.5775 German marks, compared with 1.5835 late Monday, while the dollar closed out the New York trading session yesterday at 99.90 yen, from 100.43 Monday.
In response, the benchmark 30-year Treasury bond closed down more than 1/2 a point, to yield 7.50%.
Allen Sinai, chief economist at Lehman Brothers, said the dollar's weakness is somewhat of a puzzle. He attributed it, in part, to a lack of confidence in the Clinton Administration, a better-than-expected pickup in the German and Japanese economies, downward momentum in German inflation, continuing low inflation in Japan, and no clear turn yet in either the U.S. trade deficit or Japan's surplus. Slowing growth in the U.S. economy and the perceived risk of higher inflation complete the list of near-term negatives, Sinai said.
Analysts said the dollar's slide has exacerbated fears that U.S. inflation is beginning to heat up. While the weak greenback has contributed to bond investors' concerns over mounting price pressures, the analysts stressed that it is not the only force behind the market's declines.
For example, the government bond market experienced selling related to strong news on the economy and higher commodities prices. Treasuries headed lower as strong news on the economy emerged and prompted dealers and speculative players to lighten their inventories of government-backed debt.
The Commerce Department reported sales of new single-family homes in the United States jumped 4.2% in May to a seasonally adjusted annual rate of 738,000 units. The May sales pace was the strongest since December, when sales surged to an 817,000-unit annual rate. The latest gain followed a revised 3.4% decrease in April to a 708,000-unit pace, originally reported down 6.8%.
The Conference Board reported its consumer confidence index rose to 92.0 in June from a revised 88.9 in May. The May index was originally reported at 87.6.
On the commodities front, the Commodity Research Bureau's index of 21 futures prices closed up more than 2 1/2 points to 230.40.
Interpreting all the news as bad for fixed-income investments, bond market participants sold a moderate amount of securities. Players found the statistics particularly disturbing because they suggested that despite higher long-term interest rates, consumers continue to feel good about the economy and are putting their money where their mouths are.
Still, the bond market's primary focus remains the fragile U.S. dollar. The dollar's declines have raised widespread fears of import-led inflation.
Dollar weakness is a negative for fixed-income investors because of the inflationary implications inherent in a declining currency's value. Lower currency rates are inflationary because they generally make imports more expensive, provide an umbrella for domestic retailers and producers to raise prices, and shift demand toward U.S.-made products while factories are running near full capacity.
The problem for the bond market in such a rising-inflation scenario is the lack of demand for U.S. government and corporate securities, especially among foreign investors. Without the help of funds flowing out of other markets into U.S. investments, fixed-income observers continue to argue that the bond market will have a difficult time recovering recent losses.
Against that backdrop, market observers remain mixed on whether the central bank would boost credit in coming weeks to bolster the sagging dollar. Much of the debate centers on whether the Fed would be willing to support the dollar at the expense of maintaining economic expansion.
The real question remains how much danger does the dollar's declines against the German mark and Japanese yen pose for fixed-income investors? The jury is still out.
Putting things in perspective, bond market analysts agree changes in the value of a currency must be viewed against the gamut of currencies -- not only the two most commonly traded in the foreign exchange market. For example, while the U.S. dollar has nose-dived against the mark and yen, it has generally appreciated this year against the Canadian dollar and Mexican peso. Canada and Mexico are the United States' two largest trading partners.
In addition, noted Michael Moran, chief economist at Daiwa Securities America Inc., Treasury yields have remained within their well-established ranges, despite the dollar-related volatility that the market has experienced in recent sessions.
On the bright side for fixed-income investors, statistics released yesterday on import prices for May by the Labor Department revealed little evidence of import inflation. Though import prices rose 1.1% last month, on a year-over-year basis, import prices were up just 0.3% last month.
"The numbers are not horrible and suggest import price pressures haven't picked up all that much," Moran said. He noted that excluding petroleum, import prices edged up 0.2% last month, following a 0.3% increase in April.
But bond investors are not getting ahead of themselves. They realize that one possible explanation for why the dollar's declines have not yet translated into higher import prices is that there is typically a long lag between exchange rates and any impact on final prices. In all likelihood, Moran said, it will take at least three months for the drop in the dollar to translate into higher import prices.
Another possible reason is that while the dollar has declined against other currencies, exporters in foreign countries will normally allow profit margins to decline rather than risk raising prices in dollar terms and risk losing U.S. market share.
"The bottom line is that we haven't seen import prices rise yet as a result of the weak dollar, but we're not ruling out the possibility down the road," said Michael Niemira, economist at Mitsubishi Bank.
In futures activity yesterday, the September bond contract ended down 31/32 at 102.09.
In the cash markets, the 6% two-year note was quoted late yesterday down 2/32 at 99.25-99.26 to yield 6.10%. The 63/4% five-year note ended down 10/32 at 99.15-99.17 to yield 6.86%. The 7% 10-year note was down 14/32 at 100.02-100.06 to yield 7.22%, and the 6 1/4% 30-year bond was down 19/32 at 85.02-85.06 to yield 7.50%.
The three-month Treasury bill was down two basis points at 4.25%. The six-month bill was unchanged at 4.72%, and the year bill was up six basis points at 5.43%.
Corporate Securities
Ferrellgas LP and Ferrellgas Finance Corp. sold a $250 million junk offering consisting of a class of fixedrate senior notes and a class of floating-rate senior notes, said lead manager Donaldson, Lufkin & Jenrette Securities Corp.
The first tranche, consisting of $200 million of fixed-rate debt, was priced at par to yield 10%. The notes are noncallable for four years.
The second tranche, consisting of $50 million of floating-rate notes, was priced initially at par to yield 7.875%. The tranche is set to float 312.5 basis points more than the three-month London Interbank Offered Rate. It is noncallable for one year.
The issue is rated B1 by Moody's Investors Service and BB-minus by Standard & Poor's Corp.
In the secondary market for corporate securities, spreads of investment- grade issues widened by 1/2 to 3/4 of a point, while high-yield issues generally ended mixed.
Rating News
Standard & Poor's said the ratings on Kemper Corp.'s BBB senior debt and BB-plus preferred stock remain on CreditWatch with "developing" implications following the company's acceptance of Conseco Corp.'s $2.68 billion takeover offer.
Standard & Poor's said the developing implications, which mean ratings may be raised or lowered, reflect the continuing possibility of a Kemper merger with either a higheror lower-rated entity.
While the company has entered into a merger agreement with Conseco, the possibility exists that Kemper may, under certain circumstances, terminate its agreement in favor of another company, Standard & Poor's said.
