Treasury prices plunged Friday, with the yield on the 30-year bond shattering the 7.75% barrier when the Federal Reserve reported the inflationary news that capacity utilization has risen to its highest level since April 1989.
The benchmark 30-year Treasury bond closed down 1 18/32 points Friday, to yield 7.76%.
The 10-year Treasury note was down 11/8 points to yield 7.49%. The seven-year note was down 31/32 to yield 7.32%, and the five-year declined 22/32 to yield 7.11%. Also on Friday, the December Treasury bond futures contract dropped to its lowest price since January 1993. With the August capacity utilization figure sending the 30-year cash bond to its highest yield since June 1992, bond futures broke below the 99 8/32 -low set on July 11. The point and a half drop triggered additional selling, including stop-loss selling.
The December Treasury bond futures contract closed one and a half points lower at 99.08.
The dollar also tumbled against major currencies after the Fed report, leaving it near the bottom of recent trading ranges. Foreign currency futures rallied in response to the bond market's losses, however. At market close, the dollar was quoted at 1.5325 German marks and 98.55 Japanese yen.
On Sept. 9, the long bond dropped a point and a half after the producer price index was reported up 0.6% rather than the expected 0.4%. The Friday before that, the 30-year plummeted around 1 1/2 points on news of Columbia University's highest inflation index in five years, to end down a half, yielding 7.48%.
In the three days prior to last Friday, the market did show some bullishness on indications of a slowing economy, with bonds closing each day slightly higher. But some economists warned that the apparent rally was little more than a technical correction.
"This is an extraorodinary blowout," David Munro, chief U.S. economist for High Frequency Economics, said on Friday after bonds plummeted again. "I don't see how yesterday or today can represent anything more than confusion. We were so happy yesterday, so glum today. We're certainly getting mixed signals on the economy."
With such tremendous price movements for the third Friday this month, analysts said, the market may have entered a new trading range.
"We seem to be losing ground every time with this seesaw pattern," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc. "We seem to be going toward higher rates,"
Friday's market spike resulted from the Fed's report that the capacity utilization rate in manufacturing hit 84.7% in August, far above economists' consensus figure of 84.1%. The Fed also reported that industrial production rose 0.7% in August, again exceeding expectations of a 0.5% rise.
U.S. capacity utilization last month was at a five-year high, Wesbury pointed out on Friday. "That was the big shock here today. That 84% to 85% range is where bottlenecks crop up in the production process," he said. "When you're using that much of your capacity, any mistake becomes more expensive.
"We're using so much capacity that we're not filling orders as fast. As orders aren't filled, price pressures are growing because people are willing to pay more for goods," Wesbury said.
"The economy has caught a tail wind."
Retail sales, consumer confidence, initial claims, auto sales, and industrial production and capacity utilization "are all showing strength," Wesbury said. "The bond market is very concerned about that today."
Another Fed tightening before November is increasingly becoming a possibility, Wesbury said. Calling recent Federal Reserve policy "excessively easy," he said he could see an 8.5% long bond by early next year.
"They haven't really tightened yet," Wesbury said of the Fed, even though the federal funds rate is up 1 3/4% since the beginning of 1994. "Inflation is 2% higher than last year," he said.
Adding to Friday's bearishness was the University of Michigan's survey of early September consumer sentiment, which rose to 92.2 from 91.7 in August. Further, the survey's consumer expectations index rose to 85.3 in early September from 80.8 in August.
The news on inflation has also meant increasing activity in T-bills, which show expectations of a Fed tightening, according to Wesbury. "If I thought the Fed was going to hold short-term interest rates at 4 3/4%, I would buy one-year T-bills all day long. But they're not, which is why one-years are up 10 basis points," he said.
Compared to the federal funds rate, T-bill spreads are at historic highs, Wesbury said, which signifies that investors are expecting sharp increases
in short-term interest rates in the years to come.
The yield on the three-month bill was up three basis points to 4.71% on Friday. The yield on the six-month bill was up nine basis points to 5.22%, and the yield on the one-year rose 10 basis points to 5.78%.
With the economy reaching capacity restraints and increasing price pres- sures, a bill trader said, the market's mini-rally earlier in the week "was trading more off technicals than fundamentals ."
The three-month bill still remains the safest place to stay, the broker said . "I'm going to continue to wait for the Fed to tighten and stay short the mar- ket," he said.
This week should be "light on inflation and growth indicators," said Munro of High Frequency Economics in a report published Friday. He said investors would have to shift their focus to the Federal Open Market Com- mittee's meeting scheduled for Sept. 27.
"A few analysts are surmising that the strong retail and production indi- cators this week will inspire a pre-emptive Fed hike in rates, well ahead of the Nov. 8 nationwide elections," Munro wrote, adding, "I do not expect that."
He also warned that Wall Street may react this week to President Clinton's threat to invade Haiti. "There's as much angst in Washington as in Port- au-Prince," Munro said in a telephone interview Friday. Congress is willing to challenge Clinton's low credibility in foreign affairs, he said, "and that co uld cause concern in the markets."