News of improved consumer sentiment is giving fixed-income investors less confidence in holding Treasury securities.
That was evident in the selling frenzy that followed the release of a regional report on consumer sentiment Friday. Investors ran for cover after news that the University of Michigan's index posted a solid increase to 87.7 in November from 81.2 in October.
Treasury prices ended sharply lower across the board, with the 30-year bond closing down 3/4 of a point, to yield 6.20%.
Coupled with last month's surprising surge in the Conference Board's report of consumer confidence and broad-based signs that consumers are feeling better about the economy, the Michigan survey presents Treasuries with a formidable challenge this week.
Market observers fear that this week's gamut of economic statistics will depict even stronger growth than was previously thought and encourage players to sell government-backed paper. Scheduled releases include November retail sales, November industrial production and capacity utilization, October business inventories, and the latest business index from the Federal Reserve Bank of Philadelphia.
The risk for treasuries is that upcoming economic figures may prompt Wall Street firms to hike their already upwardly revised forecasts for growth in the fourth quarter of 1993. While the market has spent the better part of the last month pricing in a strong finish to the year, many players now fear that the ongoing acceleration in the economy will carry over into next year.
"The good news on the economy is bad news for the bond market in the future," said James Kenney, head trader at Prudential Securities Inc., noting that the first quarter of 1994 could perform better than many analysts now expect.
Much of the market's ability to resist further price losses was based on the belief that regardless of faster growth in the fourth quarter, conditions would dampen in the first quarter of 1994. While many bond market participants believe this scenario remains intact, some are beginning to prepare for the worst.
Market observers point to a number of developments in the market to support their case for sustained growth next year. Money managers, they say, are reducing the duration of their portfolios in order to protect their holdings from a potential spike in interest rates. In addition, manufacturers are reporting increased production schedules to meet mushrooming consumer demand for durable goods.
"Studies are showing that despite heavy production schedules, manufacturers have not been able to increase their inventories all that much, which suggests to me that sales are exploding," said Michael Strauss, chief economist at Yamaichi International Inc.
Strauss also pointed toward signs that banks are once again in a lending mode. He calculated that in the last month, banks have pulled roughly $9 billion out of the intermediate- and short-dated Treasuries in a move to satisfy growing loan demand.
Despite better growth in the economy, inflation has yet to pose a significant threat. However, observers believe the potential is there. The great debt market rally of 1993 was predicated on the belief that the overall inflation rate was moving lower. But in recent weeks, upward pressures in some inflation indicators have dealt a sobering blow to the bond market and supported the notion that inflation remains low, but not dead.
"There are no upward signs of pressure in inflation yet, but past performance is not a good indicator of future performance," said Charles Lieberman, director of financial markets research at Chemical Securities Inc.
Still, many participants remain bullish on the U.S. bond market in the long term. Among them, Philip Braverman, chief economist al DKB Securities, believes that a "pronounced drop in economic growth next year, especially in the second quarter, will further depress inflation and reinforce a renewed downtrend in bond yield."
Friday Market Activity
Treasury prices slid lower Friday as good news on the economy turned out to be bad news for bonds.
The Labor Department reported that the consumer price index rose 0.2% during November, right in line with most forecasts. The core rate, which is the CPI without food and energy, also came in as forecast with a 0.3% increase.
Market participants said the modest increase in consumer prices in November demonstrated that inflation remains low and supported the notion that there is little risk that the Federal Reserve will raise short-term interest rates any time soon.
Coupled with the November producer price index, players believe that the inflation picture remains constructive for Treasuries.
Higher commodity prices adding to selling pressures Friday. The Commodity Research Bureau's index edged higher throughout the day, closing up 1.41 points at 224.80.
In futures Friday, the March bond contract ended down 12/32 to 119.10.
In the cash markets, the 4 1/4% two-year note was quoted late Friday down 3/32 at 100.01-100.02 to yield 4.21%. The 5 1/8% five-year note ended down 10/32 at 99.28-99.30 to yield 5.13%. The 5 3/4% 10-year note was down 18/32 at 100.01-100.05 to yield 5.72%. And the 6 1/4% 30-year bond was down 24/32 at 100.15-100.19 to yield 6.20%.
The three-month Treasury bill was down one basis point at 3.06%, the six-month bill was unchanged at 3.25%, and the year bill was up three basis points at 3.50%.Treasury Market Yields Prev. Prev. Monday Week Month 3-Month Bill 3.10 3.12 3.116-Month Bill 3.32 3.28 3.241-Year Bill 3.62 3.45 3.392-Year Note 4.21 4.20 4.093-Year Note 4.52 4.52 4.445-Year Note 5.13 5.13 5.007-Year Note 5.27 5.32 5.2210-Year Note 5.72 5.74 5.6430-Year Bond 6.20 6.23 6.14