When Philip Braverman and a handful of Wall Street observers predicted two years ago that the 30-year bond would yield 6% by the end of 1993, the roar of laughter could be heard on trading floors around the world.
After all, the economy was on the rebound. Federal Reserve Board officials were forecasting higher inflation, and consumer loan demand was perking up.
The idea of a 6% yield on the 30-year bond was thought to be as likely as a snowfall in the Caribbean.
They are not laughing anymore. In fact, many of the players who said the bond would never even approach a 7% yield are now singing along with the the market's bullish tone. And Friday's action only added to the chorus, with the long bond up another 1 1/4 points to yield 5.87%.
"Everyone has realized there's nothing on the horizon to make the economy look better," said Braverman, chief economist at DKB Securities.
The long bond first ducked below 6% on September 3rd when the employment report for August displayed surprising weakness in the economy. The message from the data was clear: The economy is growing but not fast enough to create new jobs or boost inflation.
Against that backdrop, Treasury market participants can think of few reasons why yields, particularly at the long end of the curve, will not move lower.
"The factors that brought us here are still intact, and the market is awash with liquidity pouring in from different sources," said Lawrence Leuzzi, head of government trading at S.G. Warburg & Co.
He said the weakness of the economy and lack of inflation pressures are reason enough for Treasuries to extend recent gains. However, he said the market has something else going for it: scarcity.
The Treasury Department's supply calendar is extremely light through the end of the year. Other than the weekly bill auction and monthly notes sales, dealers will need to absorb the quarterly refunding in November, which will not include an offering of 30-year bonds.
"The basic supply and demand relationship will keep the market well supported," Leuzzi said.
Participants said the ability of the 30-year bond to stay below the 6% yield level has made the Treasury market the fixed-income market of choice.
Thus, money continues to move into Treasuries from a variety of sources, including retail accounts, central banks, state and local governments, and mortgage market participants. U.S. banks, normally an important source of sponsorship for short and intermediate Treasuries, also got back in on the action last week.
"Banks sat on their hands to see if loan demand would pick up and it didn't," said Bill Feezer, head trader at Sanwa-BGK Securities. "They have a shrinking loan base and they're putting the money into Treasuries. "
But euphoria brought on by the recent rally has not eclipsed the fact that note and bond prices are vulnerable to corrective pressures. There is the belief that prices have risen too far, too fast and that the market may be ripe for a correction.
Observers warn, however, that moderate price declines in coming sessions should be interpreted as an attempt to bring the market to a level that players are comfortable with, and not as a reversal of the trend.
"The market will get overbought from time to time and correct itself, but it's tough to get to negative on the market," Feezer said.
The next test for the seemingly bulletproof Treasury market is tomorrow's consumer price index report. As with Friday's producer price index, economists expect the release to provide further evidence that growth in inflation is not a concern for the bond market.
"I don't see many forces in the economy that could hurt the market at this time, " said Brian S. Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson. "We have weak growth and low inflation and investors who want Treasuries."
Wesbury voiced confidence that Treasuries can hold onto recent gains, despite a sell-off late last week, which pushed yields higher and cast an element of uncertainty into the market's outlook.
Treasury Market Friday
Treasury note and bond prices rose Friday in reaction to an unexpected decline in the producer price index.
The 30-year bond was up about 1 1/4 points to yield 5.87%.
Prices firmed as-dealers covered short positions on news that inflation remains under wraps and is unlikely to kick up anytime soon.
The producer price index for August plunged 0.6%, the biggest monthly decrease in two-and-a-half years. The fall in prices, largely the result of lower tobacco prices, marked the fourth straight monthly downturn after decreases of 0.2% in July, 0.3% in June, and 0.1% in May. Analysts had been expecting a small rise in the August price index in the range of 0.2%.
Jerry Zukowski, economist at PaineWebber Inc., said that while the overall inflation picture remains positive for the market, the initial headlines of the producer price index report appeared better than the overall report.
"It's a tobacco story," he said, noting the decline in tobacco prices reflected ongoing price wars among the nation's cigarette manufacturers. Zukowski said without the volatile tobacco component, the producer price index rose about 0.2% in August.
"It's the same picture on inflation that we've seen. There are few upward price pressures in the economy," he said.
The short end of the curve benefited from the numbers because they provided further evidence that the Fed will not need to tighten rates any time soon. Coupled with a decline in commodity prices, the inflation data gave investors reason to buy the long end of the curve.
In futures, the September contract ended up 102/32 to 121.16.Treasury Market Yields Prev. Prev. Friday Week Month3-Month Bill 3.01 2.99 3.066-Month Bill 3.14 3.10 3.191-Year Bill 3.29 3.22 3.382-Year Note 3.77 3.69 3.963-Year Note 4.06 3.99 4.355-Year Note 4.65 4.62 5.047-Year Note 4.86 4.87 5.3410-Year Note 5.27 5.29 5.7030-Year Bond 5.87 5.93 6.34Source: Cantor, Fitzgerald/Telerate
