The short end of the Treasury market is carrying the weight of the investment world on its shoulders this week as renewed expectations for tighter monetary policy and new supply confront investors.
Short-dated Treasuries took the brunt of last week's sell-off as accounts moved money to other parts of the yield curve ahead of what many see as an imminent Federal Reserve rate increase. By contrast, longer-dated governments outperformed the shorter maturities because investors believe that the long bond has the most to gain from tighter credit conditions.
Pressure on the short coupons is intensifying as primary dealers prepare to absorb $28.25 billion of new supply as part of the Treasury's monthly note sales.
"It will be a yield-curve-flattening phenomenon we will likely confront," said William Sullivan, director of financial markets research at Dean Witter Reynolds Inc.
The bond market is expected to remain under pressure this week as bend investors adjust to the likelihood that the central bank will tighten monetary policy sooner than previously expected, observers said.
Fed chairman Alan Greenspan, in his semiannual Humphrey-Hawkins testimony last week before the Senate Banking Committee, indicated that the central bank is still concerned over the pace of economic growth, inflation, and the weak U.S. dollar. Bond market players took the comments to mean that the Fed will again raise rates.
"You'd have to be brain dead to believe that Greenspan was not setting the stage for another tightening," Sullivan said. Against that backdrop, "supply looms ever present as a significant challenge."
As the bend market enters a period of supply this week, players expect a concerted effort by the dealers to push Treasury yields higher. Building a concession into the short end, particularly the when-issued two- and five-year notes, is crucial to the market's ability to absorb the new supply and distribute it afterward, observers said.
Daniel Seto, money market economist at Nikko Securities Co., expects the market to attempt to raise the yield on the when4ssued two-year issue to 6.25% and the five-year close to 7% ahead of the auctions.
"With the Fed threatening to tighten, I'd say supply is a pretty good obstacle," Seto said. "The market will have to cheapen the issues ahead of the auctions."
But beyond this week's note auctions, fixed-income market participants are setting their sights on the August refunding, where the market will absorb more than $40 billion of new Treasury debt. The upcoming refunding includes a 30-year bond offering.
Fixed-income professionals will get their first comprehensive look at the economy's performance in the second quarter this week as the Commerce Department releases its latest reading on gross domestic product. Economists polled by The Bond Buyer generally expect the release to show that the economy grew 3.6% in the second quarter.
Mary Dennis, money market economist at Merrill Lynch & Co., expects GDP growth to come in at 3.5%, although she agrees there is a slight upward risk. Most of the strength, she said, will come from large inventory accumulation and from a rebound in the construction-related sectors, which were hurt by bad weather in the first quarter.
The implicit GDP price deflator is expected to rise at a 2.2% rate in the second quarter after rising by 2.6% in the first quarter, Dennis said. Higher import prices are likely to contribute to the better reading in the overall price index. The fixed-weight GDP price index is likely to rise at a 2.5% annual rate in the second quarter compared to a 3.2% pace in the first quarter, Dennis said.
The wild card this week will be the U.S. dollar's performance in global currency markets. The greenback gained considerable ground last week as Treasury and Bundesbank officials suggested they would like to see the currency appreciate in value.
The dollar also got some mileage out of Greenspan's congressional testimony last week. Greenspan mentioned the greenback as one of the Fed's major concerns about the economy, suggesting rates are headed higher soon.
Dean Witter's Sullivan said concerns over the dollar could intensify this week as trade negotiations between the United States and Japan resume. "There could be some potential heating up, and we'll have to keep our eyes on the exchange markets," he said.
Some market observers believe the bond market will be virtually rangebound in coming sessions ahead of several significant events in coming weeks.
Charles Lieberman, director of financial markets research at Chemical Securities Inc., said the market wants to see the July employment report before attempting to exit recent ranges. Asserting that the upcoming jobs report will play a major role in the Fed's deliberations about monetary policy and the success of the August refunding, Lieberman said Treasuries are probably destined to play the range.
In the futures market, the September bond contract ended down 1/32 at 102.22.
In the cash markets, the 6% two-year note was quoted late Friday down 2/32 at 99.25-99.26 to yield 6.10%. The 6 3/4% five-year note ended down 4/32 at 99.10-99.12 to yield 6.90%. The 7 1/4% 10-year note ended down 7/32 at 99.23-99.27 to yield 7.27%. The 6 1/4% 30-year bond ended down 7/32 at 84.18-84.22 to yield 7.55%.
The three-month Treasury bill ended up five basis points to 4.46%. The six-month bill closed up four basis points to 4.94%. The year bill ended up two basis points to 5.52%.
Corporate Securities
Activity in the corporate securities market heated up last week as issuers took advantage of stability in Treasuries and buyers came off the sidelines.
Against the backdrop of improved conditions for U.S. fixed-income markets, a number of corporate treasurers found the primary market ripe for their offerings.
"The rally in the Treasury market gave an assist to the week's new issues, some of which were aggressively priced," said C.J. Smith, corporate analyst at Mabon Securities Corp.
The volatile governments market held new-issue corporate volume to a minimum in recent weeks. Last week, however, bond market participants had a more optimistic view of their prospects now that the economy has displayed the mark of slower growth.
Spreads of investment-grade issues ended down 1/4 of a point Friday, while high-yield bends ended narrowly mixed. Treasury Market Yields Prey Prey. Friday Week Month 3-Month Bill 4.46 4.35 4.25 6-Month Bill 4.94 4.85 4.75 1-Year Bill 5.52 5.33 5.36 2-Year Note 6.10 6.01 6.06 3-Year Note 6.42 6.36 6.36 5-Year Note 6.90 6.83 6.83 7-Year Note 7.06 7.02 6.86 10-Year Note 7.27 7.23 7.20 30-Year Bond 7.55 7.54 7.51 Source: Cantor, Fitzgerald/Telerate
