Treasury prices ended mixed yesterday after a session of volatile, seesaw trading Caused by the chaotic conditions in European currency markets.
Late in the afternoon, the 30-year bond was off point to yield 7.32%, while short-term notes were up 1/8.
"All the price action has been currency driven," said Anthony Karydakis, a senior financial economist at First National Bank of Chicago.
Mr. Karydakis described the day's trading as "very volatile, unpredictable, and on balance directionless."
He said the fluctuations in European exchange rates should not have that direct an impact on Treasury prices, but that the wire reports of European events were having a psychological impact.
"The market has become very emotional and all the developments in Europe have provided an excellent opportunity for trading," he added.
With Sunday's French vote on the Maastricht accord rapidly approaching, the British pound came under heavy pressure in overseas trading from speculators moving funds into the German mark in anticipation of a no vote.
In an attempt to keep the pound within the limits set by the Exchange Rate Mechanism, which links the major European currencies, the Bank of England raised its base lending rate to 12% from 10% in overseas trading, and then boosted it to 15% a few hours later.
The Belgians and the Dutch both cut,key rates in an attempt to resolve the situation, while Sweden boosted its marginal lending rate from 20% to 75%, then later to 500%. to bolster its own currency.
The volatility the rate changes caused in the currency markets were echoed in European stock and bond markets, and also put pressure on long-term Treasury prices.
The short end of the Treasury market benefited, though, as did the U.S. dollar, because both looked like safe havens compared to the confusion in Europe.
By mid-morning, Treasury prices began to retrace their losses as a rumor spread that the Bundesbank would cut rates again at its meeting today in order to stabilize foreign exchange trading.
After sitting near Tuesday's closing levels for most of the afternoon, long-term prices faded again late yesterday when the U.K. Treasury announced it was withdrawing the pound from the Exchange Rate Mechanism for the time being and canceling its second rate increase, leaving the base rate at 12%.
Traders said the British move makes a German rate cut less likely.
William Sullivan, director of money market research at Dean Witter Reynolds Inc., said the long end's declines yesterday could reflect the pressure put on the Treasury market by the logjam of supply in the corporate market, as well as the currency crisis in Europe.
In fact, he said, the problems in Europe could be interpreted as a long-term plus for the Treasury market, since the uncertainty and higher interest rates will hinder growth overseas and cut into foreign demand for U.S. exports.
Kathleen Stephansen, a senior economist at Donaldson, Lufkin & Jenrette Securities Corp., said the bond market seemed to be over-reacting.
As long as the dollar holds its ground, the turmoil in Europe should not matter that much to the Treasury market, she said. "In fact, the market could benefit a tad from the safe haven reaction."
Late yesterday, the dollar stood at 1.5090 German marks, up from 1.4928 late Tuesday, and at 125.05 Japanese yen, up from 124.35.
There was some speculation in the bond market yesterday that the currency crisis in Europe could spell the end of the European Monetary System. But Ms. Stephansen derided that notion.
Achieving a common currency in Europe is an "enormous historical step," she said, and it is unreasonable to expect that goal to be reached without any setbacks. "Even if you have a no vote on Maastricht, I'm sure there will be another version a year later," Ms. Stephansen added.
The volatility in European markets could continue into the weekend and even beyond, participants said.
"Things are not going to calm down until you get the Maastricht vote out of the way," Mr. Karydakis said. He added that the situation might not improve all that much if the treaty is approved by only a narrow margin.
Traders said that even though the market responded to every move in Europe yesterday, they found it hard to determine exactly what the developments in Europe mean for U.S. interest rates.
In the midst of the confusion, some said it was best to concentrate on the economic fundamentals, which still favor the Treasury market, as yesterday's industrial production report confirmed. August industrial output declined 0.5%, a bit more than economists expected, and last month's capacity utilization fell to 78.5% from a revised 79.0% in Jul . "The bottom line is that the Fed will certainly keep interest rates at these levels or a little lower, and that funds at 3% make two-years worth between 3.75% and 3.95%," said James Kenney, head of Treasury trading at Prudential Securities.
He said the outlook for the long end was less certain.
"What it comes down to is that at the level of 71/4%, the long bond doesn't have a lot of sponsorship." Mr. Kenney said. "Every time we approach that level, we just can't hold it."
The Treasury announced yesterday it will sell $14.5 billion of two-year notes next Tuesday and $10.5 billion of five-year notes next Wednesday. The two-year issue was reduced by $500 million, but traders said that was not a significant change.
Late yesterday, the when-issued two-year note was bid at 3.86% and the five-year note was bid at 5.39%.
The December bond futures contract closed 5/32 lower at 105 11/32.
In the cash market, the 71/4% 30-year bond was 7/32 lower, at 99 30/32-100 2/32, to yield 7.32%.
The 6 3/8% 10-year note fell 2/32, to 99 28/32-100 2/32, to yield 6.37%.
The three-year 45/8% note was up 3/32, at 100 24/32-100 26/32, to yield 4.32%. Rates on Treasury bills were lower, with the three-month bill down three basis points at 2.90%, the sixmonth bill off two basts points at 2.92%, and the year bill five basis points lower at 3. 01 %. in other news yesterday, Discount Corp. of New York, a primary dealer of government securities, announced a I 0 cent dividend payable Oct. 15, which matches the dividend paid last October.
Treasury Market Yields
Wedneway Week Month
3-Month Bill 2.94 2.96 3.12
6-Month Bill 2.98 3.02 3.21
l-Year Bill 3.09 3.15 3.33
2-Year Note 3.79 3.83 3.99
3-Year Note 4.32 4.31 4.52
5-Year Note 5.34 5.24 5.39
7-Year Note 5.88 5.80 5.94
10-Year Note 6.37 6.32 6.45
30-Year Bond 7.32 7.24 7.31
Source: Cantor, Fitzgerald/telerate