The Treasury 30-year bond yield broke below 7 1/2% in turbulent trading last week as long-term prices outpaced the short end of the market.
This week, Treasury activity is likely to quiet down as participants wait for Friday's key July employment report. But analysis said they expect long-term Treasury paper will continue to outperform the rest of the market over the long-term, as investors extend the maturity of their holdings in search of higher yields.
"Over all, I expect activity will be light as people try to get a sense of how the world will change on Friday," when the July jobs report gives the market its first good look at last month's economic activity, said Charles Lieberman, a managing director at Chemical Securities.
Mr. Lieberman is expecting a 150,000 increase in July payrolls, which is above the consensus forecast for a 110,000 rise. Some economists are also looking for a hefty upward revision in the June number.
He said the most "coherent" way to assess the payroll numbers was to average the June and July figures.
"When you do that, what we're looking at is an increase of about 15,000 jobs a month," Mr. Lieberman said. "That's nothing to write home about."
Still, economists say the expected increase in payrolls will be enough to give the Treasury market a pause, and especially the short end of the market, where it will kill any remaining hopes of a near-term easing in Fed monetary policy.
"I think the front end is more vulnerable than the long end," said Ward McCarthy, a managing director at Stone & McCarthy Research Associates.
The fact that inflation is on its best behavior and portfolio managers will continue to search for decent yields will support intermediate and long-term prices, Mr. McCarthy said.
He warned, though, that fund managers are "pretty tapped out" right now.
Stone & McCarthy's survey of fund managers shows the duration of their portfolios is "as long as it has been since the beginning of January," Mr. McCarthy said.
Treasury Market Yields
Friday Week Month
3-Month Bill 3.24 3.21 3.28
6-Month Bill 3.36 3.32 3.39
1-Year Bill 3.60 3.54 3.66
2-Year Note 4.38 4.19 4.43
3-Year Note 4.84 4.65 4.95
5-Year Note 5.81 5.63 5.95
7-Year Note 6.25 6.18 6.43
10-Year Bond 6.70 6.72 6.88
15-Year Bond 7.04 7.08 7.25
30-Year Bond 7.45 7.53 7.61
Source: Cantor, Fitzgerald/Telerate
Treasury note and bond prices closed 1/4 to 3/4 point lower Friday after the morning's healthy economic indicators gave participants another excuse to sell short-term and intermediate notes.
The selling also hurt the long end, where the 30-year bond closed 3/8 point lower to yield 7.45%. But other coupons did even worse, with short-term and intermediate notes down 1/4 to 1/2 point.
A note trader said the price declines were a logical development, given the surprisingly strong economic news and the big inventories the Street had accumulated from the market rally and the two note auctions earlier in the week.
The worst news from the bond market's perspective was the 3.5-pump jump in the Chicago purchasing managers' July index, said Stephen Gallagher, an economist at Kidder, Peabody & Co.
The Chicago index rose to a seasonally adjusted 59.2 in July from 55.7 in June.
That Chicago increase, together with the improvement in the Philadelphia index released a couple of weeks ago, provide "convincing evidence that things have improved in July, there's better growth ahead, and fewer chances for Fed easing," Mr. Gallagher said.
The Chicago index also suggested this morning's July report from the National Association of Purchasing Management may be stronger than expected, traders said.
The 2.3% increase in June factory orders was also above the market's expectations of a 1.4% gain, while the 3.8-point drop in the University of Michigan's July survey of consumer sentiment looked a little healthier than the 11.6-point plunge in the Conference Board's July index reported earlier.
The flat June personal income report and the 0.5% gain in June spending were in line with expectations.
Prices were volatile again Friday, and traders said many rumors circulated about what was moving the market, including talk of hedge funds selling short-term paper and moving the money out the curve.
A couple of participants said some investors had begun to sell Treasury paper and reinvest the money in mortgage-backed securities Friday as the panic about prepayment risk wore off. Earlier in the week, intermediate-term and long-term Treasury prices had benefited as money moved out of the mortgage-backed market.
"Mortgage spreads have widened out relative to Treasuries, and at some point, the more sophisticated investors, who can evaluate convexity risk, decide it's appropriate" to purchase some mortgage-backed securities, Mr. Lieberman said.
The September bond futures contract closed 1/32 lower at 104 27/32.
In the cash market, the 30-year 8% bond was 3/8 lower, at 106 11/32-106 15/32, to yield 7.45%.
The 7 1/2% 10-year note fell 1/2, to 105 17/32-105 21/32, to yield 6.70%.
The three-year 5 7/8% note was down 9/32, at 102 19/32-102 21/32, to yield 4.84%.
Rates on Treasury bills were mixed, with the three-month bill unchanged at 3.19%, the six-month bill up three basis points at 3.28%, and the year bill four basis points higher at 3.48%.