A series of indicators showing the economy is on the verge of a recovery sent the Treasury long bond back towards 8 1/2% last week, and some analysts think the 30-year could steam right on through to 8 3/4%, especially if the inflation news this week is bad.
In the wake of the surprising rebound in May nonfarm payrolls Friday, the 30-year closed 1/2 lower on the day, and down more than 2 points on the week, to yield 8.46%. That is the highest closing yield since late November.
The totally unexpected 59,000 gain in May payrolls -- the consensus forecast was for a 78,000 drop -- confirmed the strength seen earlier last week in numbers such as the national purchasing managers index, late-May car sales, and the weekly jobless claims.
Most economists and traders are convinced the economy has touched bottom; some even believe it is beginning to grow again.
The string of better-than-expected numbers hurt Treasury prices, as did Federal Reserve Chairman Alan Greenspan's comment on Tuesday that recent statistics had increased the chances for "stronger-than-expected recovery."
Treasury Market Yields
Friday Week Month
3-Month Bill 5.72 5.68 5.58
6-Month Bill 5.98 5.91 5.85
1-Year Bill 6.36 6.15 6.09
2-Year Note 6.97 6.68 6.84
3-Year Note 7.40 6.06 7.14
4-Year Note 7.55 7.27 7.36
5-Year Note 7.94 7.70 7.73
7-Year Note 8.15 7.91 7.96
10-Year Note 8.27 8.05 8.09
20-Year Bond 8.48 8.26 8.33
30-Year Bond 8.46 8.26 8.33
Source: Cantor, Fitzgerald/Telerate
Mr. Greenspan's comments underlined the fact that the economic revival means the Fed is not likely to ease monetary policy again.
Traders said retail investors were in the market selling securities throughout the week, and Paul Kasriel, monetary economist at Northern Trust Co., said the market could face more liquidation by retail this week.
"You had a lot of institutional investors long their duration on the assumption that this recession would go on forever," Mr. Kasriel said. "You've also seen small savers moving into bond mutual funds in the last couple of months."
As investors adjust their holdings amid the continuing flood of Treasury auctions, "I think we can go to 8.75%," he said.
Over a longer term, Mr. Kasriel said it was possible the recovery could fizzle out in the fourth quarter or early next year, setting the stage for a "very big rally" in the bond markets.
The ingredients for a fizzle include slower growth in Japan and Germany and continued strength in the dollar, which would diminish overseas demand for U.S. products, and a Fed tightening as soon as late July or early August, which would cut back domestic demand, he said.
Joseph Plocek, a senior vice president at McCarthy, Crisanti & Maffei, is also expecting an 8 3/4% yield on the long bond, and said the market could get there this week if the inflation numbers are as bad as he expects.
Mr. Plocek does not agree with economists who argue that inflation will keep improving in the early part of the recovery.
Since the economy seems to be turning around, and since inflation is still stuck at a 4% to 5% level, "you've got to think the running rate a year into recovery is going to be 5%," he said. That level of inflation makes an 8 1/2% long bond rather unattractive.
Mr. Plocek pointed out that average hourly earnings have risen for three months in a row. And he is forecating more bad price numbers, calling for a 0.6% gain in Thursday's May producer price report and a 0.4% rise in Friday's May consumer price index.
Although the economic news was bad for bonds Friday, buying emerged when the long bond reached 8 1/2%.
Some people, especially those who are optimistic about inflation, argue that these yield levels are attractive.
"You may have sharp turnaround in the economy, but I don't see any reason to think this recovery will be anything but modest," said William Griggs, a managing director of Griggs & Santow Inc.
Mr. Griggs said the bond market has already fallen substantially in reaction to the signs of an economic renaissance.
"It's really backed up quite a bit," he said. "In a situation like this, I'd probably be a better buyer."
Most of this week's numbers are expected to be bad news for bonds. But analysts said the expected gain in Friday's May industrial production report was prefigured by the May jobs data, while an increase in retail sales would reflect the strength in auto sales that traders already know about.
The May employment report showed more strength than anyone expected, with nonfarm payrolls rising for the first time in seven months.
Prices moved lower overnight in anticipating of a strong report, then fell further after the jobs data were released.
The Labor Department said nonfarm payrolls rose 59,000 in May, following a revised 180,000 decline in April. That is far above the consensus forecast of a 78,000 decline and marked the first time since September that payrolls increased.
"It certainly represents a significant improvement in terms of the economy," said Robert Chandross, chief economist at Lloyds Bank. "It's the first positive number we've seen in a long time."
Economists dismissed the 0.3 point rise in the unemployment rate, to 6.9%, saying it merely reversed the fluky 0.2 point decline in April. They also noted that the rate is a lagging indicator.
Other signs of strength in the report included the 0.1 hour gain in the factory workweek and the 12,000 rise in manufacturing employment, the first gain in that sector in more than a year.
Analysts said the employment report suggests that May industrial production and personal income will be strong, and some are now calling for an increase in second-quarter gross national product.
The market made its lows for the day soon after the report, with the long bond briefly trading at an 8.51% yield.
Traders said that when retail selling failed to emerge at those levels, the market stabilized. And during the rest of the day, the long end improved, on a combination of short-covering by speculative accounts and some real retail buying.
"The flow of business seems to indicate that people like bonds at 8 1/2%," a trader said.
Short-term notes did not show as much of a bounce, but traders said there was more selling at the short end since retail investors owned more securities in that area.
They noted that all maturities were trading at attractive spreads to the fed funds rate. "There's value on a carry basis all across the yield curve," one said.
The Federal Reserve during the afternoon that April consumer installment credit rose $1.7 billion, following four monthly declines in a row. March's decrease was revised up to only $320 million from the $930 million reported last month.
The April consumer credit number was much stronger than the $1 billion drop economists expected, but traders said the market ignored the report, presumably having already gotten enough evidence of economic strength for one day.
The September bond future contract closed 5/8 lower, at 92 28/32.
In the cash market, the 30-year 8 1/8% bond was 17/32 lower, at 96 5/32-96 9/32, to yield 8.46%.
The 8% 10-year note fell 5/16, to 98 2/32-98 6/32, to yield 8.27%.
The three-year 7% note was down 5/16, at 98 28/32, to yield 7.40%.
Rates on Treasury bills were higher, with the three-month bill up one basis point at 5.57%, the six-month bill up three basis points at 5.74%, and the year bill nine basis points higher at 6.00%.