U.S. government bonds ended little changed yesterday as concerns about the dollar and the potential for tighter monetary policy kept buyers on the sidelines.
A late-day short-covering rally helped the 30-year bond recover from early declines to close up 1/8 of a point, to yield 7.33%. But sellers were generally in the driver seat, with the Treasury's benchmark down as much as 1/2 a point at times yesterday.
Several factors combined to weigh on Treasuries, including the dollar's unspectacular rally after a wave of intervention, better-than-expected U.S. factory orders in March, and speculation that the Federal Reserve might boost the discount rate.
But dollar weakness has generally eclipsed Treasury market fundamentals in recent sessions as foreign and domestic investors assess the impact of currency volatility on U.S. government bonds.
"The market is reacting to a combination of stronger economic growth, the expectation that interest rates will rise, and the weakness of the dollar," said Charles Lieberman, director of financial markets research at Chemical Securities Inc. "I think the Fed has to tighten again soon."
In a round of concerted intervention, the Fed and several foreign central banks bought dollars in currency markets to prop up the flagging the U.S. currency. Most of the intervention reflected the selling of deutschemarks for dollars.
The Fed's recent interventions in the foreign exchange arena reminded the fixed-income market that the Fed's moves to a tighter interest-rate policy did not strengthen the dollar.
Because recent rate hikes failed to bolster the level of the dollar against the Japanese yen and the German mark, bond investors are increasingly viewing the dollar's weakness as one more reason for the Fed to tighten credit.
That view continues to fuel speculation that the central bank may increase the federal funds rate again before the May 17 Federal Open Markets Committee meeting, which previously was seen as the most likely time for the next tightening.
With the dollar's recent weakness, dealers are concerned that foreign investors will stay away from next week's quarterly refunding auctions. The Treasury said yesterday that it would auction $17 billion in three-year notes and $12 billion in 10-year notes on Monday. The size of the auction was in line with market expectations.
Strong news on the economy yesterday was another negative for the bond market. The Commerce Department reported that U.S. factories orders, boosted by demand for primary and fabricated metals, rose an unexpected 1.1% in March to a seasonally adjusted $274.731 million. The increase was the seventh monthly gain in eight months and followed a revised 0.3% decrease in February, previously reported down 1%.
"Net, net, factory orders were significantly stronger than people expected and the market went down," said Donald Fine, chief market analyst at Chase Securities Inc. "The figures support the view that the economy continues to perform well."
Another dose of bad news for the market came from the Federal Reserve, which reported in its "beige book" that loan demand has grown, retail sales and home sales are strong, and the manufacturing sector continues to expand, with some key sectors operating close to capacity.
But helping to temper the report's impact on the bond market was a statement by the Fed that competition was keeping price pressures under control at the retail level, although the overall report did note some price increases for raw materials.
Reports that the Federal Reserve Bank of New York bought Treasury notes under the table on behalf of foreign central banks lent some additional support to the market.
The operation, which reportedly involved the purchase of three- and five-year notes, as well as off-the-run 10-year issues, was believed to be tied to the massive rounds of concerted foreign exchange intervention to support the dollar.
A Fed spokesman would neither confirm nor deny the report, as the Fed never comments on such operations. Foreign central banks often park excess dollars in U.S. Treasuries, market sources noted.
The dollar's weakness remains somewhat of a mystery to fixed-income market observers. Despite solid economic growth figures, low inflation, and prudent fiscal and monetary policy, the dollar continues to post declines against the yen and the deutschemark.
Former Federal Reserve Governor Lyle Gramley said the weakness in the dollar makes no sense given the underlying strength of the U.S. economy.
Gramley forecast that the Fed will raise the federal funds rate 25 basis points during the meeting of the policymaking FOMC on May 17. He predicted the Fed will raise the rate again to as high as 4.5% before the end of the year.
Speaking on CNBC's "Inside Opinion" telecast, Gramley said the trade imbalance and a weaker U.S. dollar will probably continue until political reform is accomplished in Japan.
Single-Price Auction Update
The Treasury's experiment with a single-price auction method for two-year and five-year notes seems to be working, the Treasury Borrowing Advisory Committee of the Public Securities Association said.
"Anecdotal evidence indicates that the securities are more widely distributed in a single-price auction, and the Treasury's costs do not appear to be any higher than under the multiple-price auction format," PSA panel members said in the minutes of their meeting Tuesday and yesterday that were released yesterday.
However, PSA members urged the Treasury to continue its experiment with the single-price, or Dutch, auction technique for another year because the single-price auction has not been tested in an environment of rising interest rates.
The so-called borrowing committee, comprised of market participants, also urged the Treasury to consider expanding the tests to one or more additional maturities.
Darcy Bradbury, deputy assistant Treasury secretary for federal finance, said at the Treasury's quarterly refunding briefing yesterday that no decision has been made about how to proceed on the Dutch auction front after the current test period expires. The current period is scheduled to run through August.
The advisory panel told the Treasury that there was no consensus among its members as to what maturities might be most suitable for an expanded Dutch auction test.
In a report to the Treasury, the borrowing committee said some members favored using the three-year note in an expanded test, while others said that more might be learned from longer maturities, such as 10-year notes or 30-year bonds.
"Because it is the principal objective of single-price auctions," the advisory panel said, the Treasury should "focus further analysis of the auction data on the extent to which single-price auctions encourage broader participation and less concentration among bidders."
The Treasury can be expected to indicate how it will proceed on the Dutch auction question at its next quarterly refunding briefing, in August.
In futures, the June bond contract ended up 3/32 at 104.10.
In the cash markets, the 5 1/2% two-year note was quoted unchanged late yesterday at 99.11-99.12 to yield 5.83%. The 6 1/2% five-year note ended up 1/32 at 99.03-99.05 to yield 6.70%. The 5 1/8% 10-year note was unchanged at 91.09-91.13 to yield 7.10%, and the 6 1/4% 30-year bond was up 1/8 of a point at 86.29-87.01 to yield 7.33%.
Two issuers entered the high-yield market yesterday, providing a ray of hope that more deals may hit the primary in coming sessions.
"It's encouraging that despite weakness in Treasuries, issuers are perking up and showing a greater willingness to price debt," a syndicate source said.
Container Corp. of America sold $400 million of senior notes, which were priced in two parts through lead manager Morgan Stanley & Co.
The first tranche, $300 million of senior notes due May 1, 2004, was priced at par to yield 11.25%. The notes are noncallable for five years. The second tranche, $100 million of senior notes due May 1, 2002, was priced at par to yield 10.75%. The notes are noncallable for life.
The issue is rated B2 by Moody's Investors Service and B-plus by Standard & Poor's Corp.
Waban Inc. said it issued $100 million of senior subordinated notes due May 15, 2004, via sole underwriter Bear, Stearns & Co.
The notes were given a coupon of 11% and priced at par, Waban said. Noncallable for five years, the issue is expected to be rated Ba3 by Moody's and BB-minus by Standard & Poor's Corp.Treasury Market Yields Prev. Prev. Wednesday Week Month3-Month Bill 4.12 3.96 3.636-Month Bill 4.60 4.39 4.071-Year Bill 5.19 4.86 4.652-Year Note 5.83 5.53 5.373-Year Note 6.16 5.89 5.815-Year Note 6.70 6.42 6.407-Year Note 6.76 6.49 6.5510-Year Note 7.10 6.81 6.8930-Year Bond 7.33 7.10 7.23Source: Cantor, Fitzgerald/Telerate