The long end of the Treasury market corrected sharply yesterday, pulling the rest of the market lower, as players took profits after last week's impressive rally.
The 30-year bond ended down 3/4 of a point to yield 5.84%. The benchmark bond closed Friday's session at an all-time low yield of 5.78%.
Observers said the market had been due for a correction and with no significant economic indicators released yesterday, Treasuries fell prey to a myriad of factors which conspired to bring sellers into the market.
Participants took profits on the back of stronger-than-expected news on the economy, higher commodity prices, and bank prime rate cuts. Treasury market dealers were the most aggressive sellers of government securities, with retail accounts coming in a close second.
Big picture: Market participants believe that economic and inflationary fundamentals continue to support the Treasury market, and most expect buyers to take advantage of attractive yield levels brought on by yesterday's sell-off.
"The market was bound for a correction, and we go it," said Anthony Karydakis, senior financial economist at First Chicago Corp. "People were looking for an excuse to sell." lofty levels of last week, and they were looking for an excuse to sell."
The first excuse came in the form of reports that several large hedge funds had taken short positions in the Treasury market.
USA Today reported yesterday that two influential investors, George Soros and Michael Steinhardt, believe U.S. Treasury bond prices will fall and are betting substantial sums on that view. The story reported that that Soros and Steinhardt have taken "sizable short positions" in bonds.
A series of prime rates cut by large banks was also met with selling. Three banks -- Morgan Guaranty Trust, Harris Trust & Savings, and Bank of Montreal -- cut their prime to 5.5% from 6%, a move which other banks are expected to follow. Players fear that widespread prime rate reductions may have a stimulative effect on loan demand and on the overall economy.
Another excuse to take profits was a surprisingly large increase in the latest survey by the National Association of Home Builders. The reading for October suggests an increase in prospective buyers, as 41.8% of the builders surveyed called traffic "good to very good" u sharply from 31.4% in September. Economists said the report was an encouraging sign for the housing market.
A spike in gold prices led the Commodity Research Bureau Index of commodity prices higher and helped pull the price of the long bond lower. Market participants were particularly concerned about gold prices, which rallied above the psychologically important $370 level.
"The market got surprised by signs of stronger growth and the chance that banks are going to be more willing to lend in the fourth quarter," said Tony Crescenzi, head fixed-in-come trader at Miller, Tabak, Hirsch & Co.
Crescenzi said all of these factors fueled fears that despite signs of lower inflation, a number of indications point toward a strong performance by the economy in the fourth quarter. While few market participants are predicting meteoric growth in the current three-month period, many have at least warmed up to the possibility of a strong quarter.
Treasury market observers were mixed on whether lower prime rates will stimulate the economy. Some argued that an easing of credit will result in an upsurge in corporate loan demand. There is pent-up demand for loans, and borrowers have been waiting for the cost of money to go down, some economists said, noting that the prime rate has been moving steadily lower since hitting 11.5% in February 1989.
However, the vast majority of market observers said lower prime rates probably will not have a noticeable effect on the amount of business banks do. They noted that loan growth is slow because of slack demand stemming from the consumer and corporate debt burden run up in the 1980s, and lower cost for money will not spur increased demand.
While agreeing that Morgan, Harris, and Bank of Montreal are the first of many dominoes to fall, Mickey Levy, chief economist at Nations-Banc Capital Markets, echoed most participants' views when he said that the prime rate cuts will have a negligible impact on the U.S. economy and even less of an impact on the Treasury market.
The prevailing prime rate dropped to 5 3/4 on Sept. 15, when Southwest Bank of St. Louis and Richmond, Va.-based Central Fidelity Bank cut their rates from 6%.
The next hurdle the market must clear on the path toward lower interest rates is today's housing starts report. Economists polled by the The Bond Buyer expect a reading of 1.30 million units for September.
In the cash markets, the 3 7/8% two-year note was quoted late yesterday down 3/32 at 100.02-100.03 to yield 3.83%; the 4 3/4% five-year note ended down 9/32 at 100.14-100.16 to yield 4.63%; the 5 3/4% 10-year note was down 19/32 at 103.23-103.27 to yield 5.24%; and the 6 1/4% 30-year bond was down 25/32 at 105.20-105.24 to yield 5.84%.Treasury Market Yields Prev. Prev. Monday Week Month3-Month Bill 3.01 2.99 2.996-Month Bill 3.10 3.08 3.141-Year Bill 3.26 3.19 3.382-Year Note 3.82 3.77 3.903-Year Note 4.06 4.03 4.215-Year Note 4.63 4.60 4.797-Year Note 4.80 4.80 4.9810-Year Note 5.24 5.24 5.4330-Year Bond 5.84 5.91 6.09Source: Cantor, Fitzgerald/Telerate