The Treasury market's post-tightening rally came to an abrupt halt yesterday as a myriad of developments conspired to push prices lower across the yield spectrum.
Among the factors behind the declines were a weaker U.S. dollar, sharp increases in the price components of a widely watched economic survey, and higher commodities prices. The 30-year bond closed down 1 1/8 points to yield 7.49%.
Analysts characterized the declines as profit-taking related to disappointment over the market's inability to extend Tuesday's powerful rally. Still, they said, selling yesterday should be viewed more as a correction than a shift in sentiment.
"The market's performance Thursday gives you a sense that the market has no sense of direction," said Cary Leahey, senior economist at Lehman Government Securities Inc. The market, he said, is looking for signs of a visible slowdown in key economic indicators before extending its buying spree.
Treasuries began their fall yesterday as the greenback lost ground, raising concerns among U.S. fixedincome traders that investors would avoid buying dollar-denominated assets.
The sharpest dollar declines were seen against the Japanese yen, which rose after news that the U.S. trade gap with Japan widened in June. The dollar also lost ground against the German mark after the Bundesbank failed to ease monetary policy, as many market players had expected.
Late yesterday, the dollar was changing hands at 98.65 yen and 1.5438 marks.
On the economic numbers front, the Philadelphia Federal Reserve's August economic survey showed large gains in both its prices-paid index and prices-received index. The prices-paid index spiked to a fiveyear high of 48.6 in August from 36.4 in July, while the pricesreceived component swelled to 24.5 from 15.8. The overall activity index registered 13.9 in August, up from 11.3 in July.
The report quickly resurrected worries about inflation and smothered the euphoria caused by Tuesday's Fed tightening. It also added to the defensive mood of the bond market that began late Wednesday when there was no significant followthrough to Tuesday's rally after the central bank aggressively raised short-term rates.
Further fanning inflation concerns was an increase in commodities prices. The Knight Ridder Commodity Research Bureau index of commodities futures prices rose 47 points to 230.00.
Bonds rallied Tuesday after the Federal Reserve increased both the discount and federal funds rates by 50 basis points, citing the need to contain inflation pressures in the face of strains on U.S. manufacturing capacity. The rally was fueled by enthusiasm over the size of the rate increases coupled with the belief that the central bank will not need to raise rates for awhile.
Fixed-income observers applauded the Fed's offensive stance on inflation and agreed that the central bank succeeded in assuring the market of its resolve in the face of an expanding economy.
Amid signs that the U.S. economy continues to navigate a steady path toward full capacity and evidence that price pressures are stirring, investors have grown dependent on the central bank to tighten credit conditions and renew its vow to keep inflation under wraps. By all accounts, the Fed succeeded in doing just that.
Despite yesterday's-declines, fixed-income observers generally expect the market to extend recent gains as more retail accounts come off the sidelines and purchase Treasuries. Their optimism stems from the belief that the Fed's latest tightening will restore calm to the bond market and make investors more confident about buying government paper.
Primary among the Fed's accomplishments this week was its regainmg of Credibility with the bond market, analysts said. They noted that the Fed's move was a clear attempt to demonstrate that the central bank is willing to act to head off inflation even if the mainstream indicators of price pressures, such as the consumer and producer price indexes, remain well behaved.
"The belief is down the road that long-term rates will fall as inflation is kept in check by rising short-term rates," said Ken Meiselman, executive vice president at J.B. Hanauer & Co.
Bolstering the market's performance in recent sessions has been the belief that the central bank will leave rates unchanged until November, when the Federal Open Market Commiltee is scheduled to meet again. In a press release, the Fed said that "these actions are expected to be sufficient, at least for a time, to meet the objective of sustained, noninflationary growth."
Participants interpreted that to mean that the central bank is not likely to tighten before the Nov. 15 meeting of its policymaking arm.
But the market is not getting ahead of itself. The reluctance of investors to jump back into the market with both feet reflects uncertainty about the outlook for economic growth in the second half of the year, analysts said. Bond, investors, they said, are looking for signs of a visible slowdown in key economic indicators.
In Treasury futures yesterday, the September bond contract ended down more than a point at 102.23.
In the cash markets, the 6 1/8% two-year note ended down 3/32 at 99.27-99.28 to yield 6.19% The 6 7/8% five-year note closed down 11/32 at 99.24-99.26 to yield 6.91%. The 7 1/4% 10-year note closed down 22/32 at 99.24-99.28 to yield 7.26%. The 7 1/2% 30-year bond ended 37/32 lower at 99.31-100.03 to yield 7.49%.
The three-month Treasury bill closed down three basis points at 4.64%. The six-month bill was up one basis point at 5.11%. The year bill also was up four basis points at 5.56%.
Spreads of investment-grade issues widened by 1/2 of a point, while high-yield issues weakened by 1/8 of a point.