Strong news on the economy brought the great Treasury market rally of 1993 to a grinding halt this week.
The 30-year bond ended down 3/4 point yesterday, to yield 6.02%. Note and bond prices moved to lower levels yesterday as participants tried to figure out what recent signs of strength in the economy mean for the fixed income markets.
The rally has been based on three basic premises: that the economy would remain weak in the second half of 1.993; that inflation would continue to moderate; and that the Federal Reserve would either cut or hold steady on its interest rate policy.
But economic indicators released this week have called all three of these assumptions into question, analysts said. Increases in the consumer price index, retail sales, industrial production, and Capacity utilization have cumulatively put market participants on the defensive, as the reports indicate that the economy is not performing as poorly as the market thought.
The Philadelphia Fed's survey of business conditions showed noteworthy improvement in new orders and employment, with the overall index rebounding 0.7 points in September from negative 8.7 in August. Market observers also pointed to stronger activity in the general employment sector, evidenced by recent initial jobless reports, which showed that claims are stabilizing and displaying signs of improvement. Claims were at 324,000 in the latest week.
On the Fed policy front, a New York Times story yesterday asserted that Fed vice chairman David Mullins and other central bank officials feel another cut in interest rates would not benefit the market or the economy.
"All of these things have stopped the rally dead in its tracks," said David Jones, chief economist at Aubrey G. Lanston. "It seems most are now neutral on the market as opposed to wildly optimistic."
Traders believe the market has found a new trading range around the 6% yield level and do not expect another attempt to push prices higher until fundamental news on the economy supports higher price levels.
Corrective pressures continued to drive Treasury prices lower yesterday, as a rebound in precious metal prices created some selling in overseas trading and at the opening of New York trading. The market had rallied in recent sessions as prices of gold and silver softened. But a rally in precious metal trading took some life out of the market.
The release of economic reports put further downward pressure on the market. The Labor Department reported yesterday that initial jobless claims rose 2,000 to 324,000 in the week ended Sept. 11.
Michael Niemira, economist at Mitsubishi Bank, said the labor market has shown signs of improvement in recent months. He cautioned, however, that against the backdrop of widespread layoff announcements and the continued sluggishness of the economy, it will take several more weeks of improvement in the claims reports before the market concludes that growth in the employment sector is sustainable.
The Commerce Department reported yesterday that the merchandise trade deficit declined 14.2% in July to a seasonally adjusted $10.3 billion as imports fell more than exports. This was essentially what economists had expected on average and puts the monthly trade deficit back in the range seen in March and April.
Market economists said the trade figures showed improvement from the 44% surge in the June trade deficit to $12.1 billion, but they noted that the recent trend in trade remains troublesome for the U.S. economy.
"Because of the slow growth in foreign economics we're having trouble with our exports, and the level of imports shows that consumers are not willing to buy big-ticket items," said Michael Moran, chief economist at Daiwa Securities.
The Fed's money supply figures also showed improvement in the latest week. The central bank reported that in the week ended Sept. 6, M1 rose $5.5 billion, M2 rose $12.7 billion. and M3 rose $2.3 billion.
The market also received some supportive news yesterday. The Fed reported that industrial production rose 0.2% in August from July, in line with expectations across Wall Street. The central bank also reported that U.S. industries operated at 81.8% of capacity in August, unchanged from July's revised rate.
A 0.7% surge in the manufacture of business equipment accounted for most of the gains in the production report, which does not bode well for the overall strength of the economy, economists said.
The 30-year bond continued to lead the market lower as fund managers took profits on the issue.
Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson in Chicago, said the Treasury long bond was hurt by the Republic of Italy's 30-year bond issue, which offered investors an attractive alternative to U.S. government debt. The 10-year note outperformed the rest of the issues on the yield curve as money continued to flow into Treasuries from the mortgage market. Because most economists on Wall Street are predicting that long-term rates will top out near current levels, the moderate upturn in yields has failed to halt the movement of funds out of mortgage-backed securities. The 10-year also benefited from the unwinding of hedge positions related to the Italian government's $5.5 billion debt offering.
However, if rates back up further and the volume of prepayments slows, the Treasury market would lose an important source of sponsorship. "Intermediate Treasuries could cave in if they lose the support they have gotten from mortgages." said one mortgage-backed trader at a primary dealership.
On the supply front, a news wire reported that the Treasury thinks it can meet its upcoming borrowing goals without, any changes in its current cycle of offerings. In an interview with Market News Service, Treasury undersecretary for domestic finance Frank Newman said the Treasury remains "very comfortable" with its new short-term-oriented debt management strategy and can meet any foreseeable financing needs using existing security cycles.
Newman also said increased activity by the Resolution Trust Company will not pose a noticeable burden on the Treasury.
In futures. the September contract ended up 6/32 to 120.15.
In the cash markets, the 3 7/8% two-year note was quoted late yesterday down 1/32 at 100.00-100.01 to yield 3.85%. The 4 3/4% five-year note ended down 4/32 at 100.00-100.02 to yield 4.73%. The 5 3/4% 10-year note was down 8/32 at 102.20-102.24 to yield 5.38%. And the 6 1/4% 30-year bond was down 25/32 at 102.20-102.02 to yield 6.02%.
The three-month Treasury bill was down one basis point at 2.96%, the six-month bill was down one basis point at 3.15%, and the year bill was up two basis points at 3.25%.Treasury Market Yields Prev. Prev. Thursday Week Month3-Month Bill 3.00 3.03 3.026-Month Bill 3.15 3.16 3.171-Year Bill 3.35 3.34 3.342-Year Note 3.85 3.87 3.893-Year Note 4.14 4.15 4.265-Year Note 4.73 4.73 4.947-Year Note 4.94 4.94 5.2210-Year Note 5.38 5.34 5.6030-Year Bond 6.02 5.95 6.19Source: Cantor, Fitzgerald/Telerate