Now that the Federal Reserve seems to have gotten the urge to tighten out of its system, Treasury market analysts expect fundamentals to move to the forefont.
The latest move by the central bank came last week along with a statement by the Fed that it may pause for a while after this most recent round of rate hikes. The aggressive tightening came in the form of a 50-basis-point increase in the federal funds rate to 4.2% and a 50-basis-point increase in the discount rate to 3.55%.
The Treasury market surged on the action, with the benchmark 30-year bond jumping almost two points on Tuesday and improving for the better part of the week. The benchmark issue ended Friday at a yield of 7.30%, compared with Monday's 7.44%.
But as the dust settles this week, bond investors, who were preoccupied for weeks with trying to pick the Fed's brain for clues about the direction of monetary policy, are refocusing their attention to fundamentals.
"I think the market has entered into a new trading range from where it will monitor the fundamentals and decide where to go next," said Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp. Among the factors which fixed-income observers see as dominating the market's attention are concerns about upcoming economic statistics, inflation, supply, and the weak dollar.
But most important, say market analysts, is whether or not retail accounts feel the bond market has calmed enough for them to invest idle funds. Undermining the increase in Treasury market prices last week was the fact that most of the gains came at the hands of dealers covering short positions. While traders cited scattered reports of buy-side interest in government securities, significant buying failed to emerge.
"The most important factor of the week is what portfolios do because they will make or break the market," said Anthony Karydakis, senior financial economist at First Chicago Capital Markets Inc. "We have to see whether large accounts will assess current fundamentals and yield levels as attractive."
On the positive, side, notes Karydakis, investors were encouraged by the rise in bond prices, which reflected the improved psychology that has existed in the market since the central bank's aggressive tightening move. That, he said, should convince many retail investors that it's safe to put money back into Treasuries.
"But we have yet to see significant portfolio demand for Treasuries, and that has held us back," Karydakis said.
The Fed's move was largely anticipated by the fixed-income market, Karydakis said, noting that bond investors embraced it as an unequivocal sign of the central bank's resolve in maintaining economic expansion and keeping inflation under wraps.
The aggressive tightening bolstered the Fed's credibility, market observers said, noting that the central bank's announcement included a statement suggesting that monetary policy was nearing neutrality. That, they said, should bring hordes of retail buyers off the sidelines as the threat of future tightening is at least perceived as being greatly reduced.
Fixed-income market observers said less accommodative monetary policy should give longer-term investors more confidence to place bets on government securities from the 10-year note on out the yield curve. This, they said, will probably facilitate a modest reduction in long-term interest rates in coming sessions.
Most important for the long end of the market is that the tightening removes an element of uncertainty from the bond market, enabling investors to return their focus to fundamentals.
Players said that after each of the Fed's previous tightening moves this year, it was understood that there were more rate hikes on the way, which the market always kept in mind. But after Tuesday's tightening move, analysts said the Fed will probably take a breather before boosting short-term rates again.
Still, the Fed's latest interest rate increases do not preclude further tightenings if the pace of U.S. economic expansion remains rapid, bond market analysts said. Yesterday's rate hikes indicate that the Fed has reached a level that it believes is neutral, but does not bar the central bank from acting to rein in credit again, if needed.
"The Fed's tightening went a long way toward calming world financial markets, but let us remember that there still could be more to come," a fixed-income strategist said.
In futures, the June bond contract ended down 26/32 at 105.00.
In the cash markets, the 5 1/2 two-year note was quoted late Friday down 4/32 at 99.16-99.17 to yield 5.75%. The 6 1/2 five-year note ended down 10/32 at 99.20-99.22 to yield 6.57%. The 7 1/4 0/0 10-year note was down 15/32 at 101.19-101.23 to yield 7.00%, and the 6 1/4 0/0 30-year bond was down 25/32 at 87.07-87.11 to yield 7.30%.
The three-month Treasury bill was up one basis point at 4.23%. The six-month bill was up eight basis points at 4.70%, and the year bill was up two basis points at 5.08%.
The corporate securities market came alive last week as issuers took advantage of the stability in Treasuries, and retail buyers emerged to scoop up some of the undervalued bonds in the secondary market.
With the much-awaited tightening of monetary policy finally out of the way, a number of corporate treasuries found the primary market ripe for their offerings.
"The cloud of bearishness that has hovered over the corporate securities market for weeks was replaced by relief that the Fed finally raised rates," one corporate trader said. "Both the primary and secondary markets saw more activity than they have in a while."
The volatile government securities market has held new issue volume to a minimum in recent weeks as the Treasury Department's monthly auctions met with tepid demand and investors avoided the fixed-income markets ahead of last week's Federal Open Market Committee meeting.
But improved market psychology encouraged underwriters and investors to come off the sidelines and get involved in the market.
"Most people believe the Fed is not going to move again for a while," a second corporate securities trader said. "That has restored an element of calm to the fixed-income markets and brought some some key players back into the market."
In other corporate news, Cyrus R. Vance, court-appointed mediator in the R.H. Macy & Co. bankruptcy case, said Judge Burton R. Lifland "is of the view that substantial progress has been made in the mediation process, particularly in terms of value to creditors and in accelerating a conclusion to the bankruptcy case."
In a press release, Vance said he reported the current status of the mediation process to Lifland, who is presiding over the case. Vance said Lifland directed Macy's to file a plan of reorganization as soon as possible, based on the mediation progress. Vance said he will continue in his role as mediator.Treasury Market Yields Prev. Prev. Friday Week Month3-Month Bill 4.23 4.20 3.816-Month Bill 4.70 4.83 4.341-Year Bill 5.08 5.37 4.862-Year Note 5.75 6.01 5.593-Year Note 6.11 6.38 5.985-Year Note 6.57 6.86 6.527-Year Note 6.63 6.93 6.5910-Year Note 7.00 7.27 6.9230-Year Bond 7.30 7.49 7.22Source: Cantor, Fitzgerald/Telerate