Two-thirds of bankers gathered at a conference this week said that the recent spike in interest rates is likely to continue, with rates rising by at least 50 basis points during the next 12 months.
The survey of 347 bankers, conducted by the American Bankers Association at its annual convention in San Diego, shows that 66% see rates rising, while only 7% said they expect rates to fall by at least 50 basis points over the next year. Twenty-seven percent said they expect rates to remain about the same.
The ABA's survey comes against a backdrop of recent signs of strength in the economy that have triggered a selloff in the bond market and driven long-term yields higher. It also underscores a debate raging in the Treasury market, where analysts are mixed on the long-term direction of interest rates and the economy in general.
"The direction of interest rates is really a question of whether te pick-up in growth we're seeing is sustainable," said Anthony Karydakis, senior financial economist at First Chicago Capital Markets Inc.
Most on Wall Street believe that short-term economic growth will accelerate smartly in the fourth quarter and post about 4% growth in gross domestic product. The surge in economic activity will probably be due to increased consumer demand and inventory rebuilding, particularly in the auto sector. Growth at 4% will probably create further selling pressures in the Treasury market, which could push long-term yield levels higher, analysts say.
But long term, market observers cite a number of factors that will tend to hinder any acceleration of economic growth next year. They include higher taxes and uncertainty over upcoming health-care reform, Ongoing corporate restructuring, the scaling back in the defense industry, the weak commercial real estate market, and the lack of new and innovative consumer products.
Meanwhile, as the debate over the direction of the economy wages, the market is trying to locate a comfort zone where it can tolerate stronger economic growth.
"The market is probing for a new trading range where everyone is comfortable," Karydakis said.
Yesterday's Market Activity
Trading activity yesterday provided the market with cautious optimism that the market has found that comfort zone.
The Treasury market ended the session in positive territory for the first time in seven sessions, with the 30-year bond ending up 1/8, to yield 6.19%.
Late yesterday, some participants were concluding that the market's recent consolidation has run its course and that Treasury prices may have bottomed out.
The bulk of gains reflected short-covering on positions set last week in expectation that the market would resume its slide today, When the market seemed to stabilize through the morning, dealers squared shorts.
The intermediate sector led the move higher yesterday, followed closely by the short end of the curve. Longer-dated Treasuries managed to finish the session in Positive territory, but generally performed poorly.
As has been the case for most of 1993, the long bond decoupled itself from the rest of the market and ran its own course -- posting losses early in the day and recovering in the afternoon while the rest of the curve moved into Positive territory.
No news emerged to drive trading yesterday and instead activity was dominated by position jockeying ahead of this week's auctions and economic statistics. The bulk of the trading involved the selling of the long bond and the buying of shorter issues, especially five-year notes.
The long bond's Poor Performance reflected mounting uncertainty over what impact recent signs of strength in the economy will have on inflation, traders said. Extreme volatility at the long end of the curve has made the 30-year a bit too risky an investment for accounts looking to protect profits into yearend. After a good year in the markets, investors have moved in on the yield curve to where price action is less volatile.
"The bond is weighing the long end down." said Joel Kazis, head trader at UBS Securities Inc. "People are selling the bond, which has been exceptionally rich to everything else on the curve."
The market will get its first read on price pressures this morning when the Labor Department releases its producer price index for October.
Kazis said yesterday's declines at the long end of the Treasury yield curve came at the hands of large sellers of bonds for shorter maturities. Noting that no fresh news arose to hurt the 30-year, Kazis said the issue was merely playing catchup with the rest of the market, which has sold off considerably in recent sessions.
The five-year note, on the other hand, caught a tailwind from the movement of money in on the yield curve. Traders expect the five-year to remain the Treasury market's star-performer near term, as it is one of the few areas of the curve not facing a heavy supply burden this week.
One reason the issue remains attractive is because it offers a viable alternative to the lack of return at the front end of the curve and the volatility at the long end. The issue has also cheapened significantly in recent sessions.
Demand for the intermediate sector of the market has encouraged some players who continue to argue that while the economy has gained some steam, the rate of growth is probably not sustainable and is not enough to significantly boost inflation pressures.
Still, market participants complain of a distinctive lack of retail interest for Treasuries, particularly the longer maturities.
Charles Lieberman, director of financial markets research at Chemical Securities, Inc., said the lack of retail demand for long-dated Treasuries has taken its toll on the 30-year issue and facilitated a backup in interest rates. Higher interest rates and speculation that they may move higher still have spooked many long-term investors, particularly as the end of the year draws near.
"It's been a good year in the fixed-income markets and people have made a lot of money," Lieberman said. "Some people may not be willing to stay in the market."
Market participants have plenty to focus on this week, including November's quarterly refunding and October inflation reports.
The producer price index is expected to show only a modest uptick in October and most analysts are down-playing the expected impact of higher energy costs.
Economists polled by The Bond Buyer forecast an average 0.2% increase in the producer price index and a 0.1% rise excluding the volatile food and energy components. In September, the PPI rose 0.2 percent and the core index was unchanged.
On the supply front. the Treasury will auction $17 billion of three-year notes, a $14 billion 66-day cash management bill, and $12 billion of 10-year notes.
Providing the market with an indication of what to expect from the inflation data, Treasury Secretary Lloyd Bentsen said inflation in the United States is "no serious threat."
Speaking on the cable television network CNBC, Bentsen said that current U.S. gross domestic product growth is "no barn burner" and that he sees no reason for higher U.S. interest rates, given the current low inflation environment.
Later at a press conference in Washington, Bentsen noted a slow acceleration in GDP growth rates in the first three quarters of the year to 2.8% in the third quarter. "That's nothing terribly exciting, but it's growth," Bentsen said in the press conference held to discuss the North American Free Trade Agreement.
"There are a lot of countries across Europe that would be delighted to have it, including Japan and Asia," Bentsen said. "But what you're also seeing is [growth] coupled with low inflation and continuing long-term low interest rates, which are providing a substantial stimulus to the economy."
The weekly bill auctions attracted solid demand. The Treasury auctioned $27.6 billion of new three- and six-months bills at 3.11% and 3.28%, respectively. The bid-to-cover ratios were strong at 4.06% for the three-month and 4.58% for the six-month. Market participants said the strong performance at the auctions reflected the shift into the short end and out of the long bond.
In features, the December contract ended up 28/32 to 116.04.
In the cash markets, the 3 7/8% two-year note was quoted late yesterday Up 4/32 at 99.18-99.19 to yield 4.09%, the 4 3/4% five-year note ended up 10/32 at 98.25-98.27 to yield 5.01%, the 5 3/4% 10-year note was Up 20/32 at 100.23-100.27 to yield 5.63%, and the 6 1/4% 30-year bond was Up 3/32 at 100.19-100.23 to yield 6.19%.
The three-month Treasury bill was unchanged at 3.06%, the six-month bill was down two basis points at 3.24%, and the year bill was down five basis points at 3.38%.