Broad-based buying interest hammered the yield on the bond below 6.50% yesterday and forced idle investors into the market.
The 30-year bond ended up 23/32 to yield 6.46%, its lowest level since the Treasury began regular bond auctions in 1977.
Euphoria brought on by passage of the budget last week and expectations for a successful round of quarterly refunding auctions this week brought a slew of buyers into the market.
Solid buying interest forced retail investors into the market as long bond yields plummeted and gave no sign of letting up. Strong demand was reported from retail, foreign, and speculative accounts.
"Passage of the budget was something that I as a forecaster believed was fully priced into the market," said Neal Soss, chief economist at First Boston Corp. "The move today proves that wasn't the case."
Market participants pointed to the meteoric rise of prices in fixed-income markets across the board as proof that reaction to the deficit reduction package had not been fully built into prices. Treasuries, futures, and municipals all ended the day sharply higher.
Buying the Treasuries was directed toward the long end of the yield curve, as this week's refunding auctions will be the last opportunity investors have to buy bonds in the primary market this calendar year.
The Treasury Department will this week begin its semiannual cycle of bond issuance with $11 billion in new 30-year paper. That drought of bonds created a buying frenzy at the long end yesterday and helped drag the rest of the market higher.
"Investors are acting as if this week will be the last time that the Treasury will ever auction bonds," said Charles Lieberman, director of financial markets research at Chemical Securities. "They understand that there will be scarcity value in the issue."
Last week's employment report for July supported the market's view that the economy remains on a slow growth path and that inflationary pressures are minimal at best. That news, coupled with other recent signs of weakness in the economy and expectations for steady monetary policy, has made investors more interested in holding long-dated paper.
Lieberman said the likelihood of steady Federal Reserve policy has again given investors on the buy side of the market incentives to hold interest-bearing coupons rather than roll their money into low-yielding money market instruments.
Strip buying was a major contributor of the long end's impressive performance yesterday. Zero-coupon bonds have recently become more popular with speculative investors looking to make quick gains on small moves in the market.
Brazil was rumored to be a large buyer of Strips yesterday, traders said, speculating that the purchases were related to the nation's ongoing debt restructuring.
Gilbert Clark, head of government trading at Daiwa Securities America, said that short-covering on Strips that had been sold in expectation of higher long-term rates and outright buying of zero coupon securities accounted for a large chunk of buying at the back end of the market.
Stepped-up demand for zero coupon bonds and expectations for a scarcity of bonds has helped the cash market outperform futures in the last two weeks, market participants said.
"There has been a demand for cash bonds for stripping purposes and there is a perceived future scarcity of bonds," said Joseph Plauche, senior fixed income futures analyst at Dean Witter Reynolds in Chicago.
Foreign buying was another ingredient of yesterday's rally as foreign central banks and private and institutional investors moved money into the Treasuries market.
While recent foreign interest in the U.S. bond market has been directed toward the short end of the market, positive market fundamentals have prompted those investors to put money into the long end.
James Kenney, head trader at Prudential Securities, said that the renewed buoyance of the U.S. dollar against the European currencies and expectations for steady interest rate policy has prompted a flight to quality into the Treasury market.
"Foreign accounts are making assumptions about what the Fed and the curve will do," Kenney said.
The question being passed around the Street late yesterday was: How long can the yield on bond go? Opinions were mixed.
Some participants said that the bond's performance yesterday defied conventional market wisdom. While few dealers doubted that fundamentals are solidly in place for lower bond yields, many voices surprises at yesterday's spike in prices.
"The question is, why do you want to buy long bonds at these levels when you could possibly get them cheaper at some other time?" said Robert Brusca, chief economist at Nikko Securities. "The economy seems to be doing a bit better near term and should do better later in the year, and I don't think the market is focusing on that."
Brusca believes that the market is a bit pricey at current levels and expects yields to back up ahead of the refunding auctions this week.
On the other side, Chemical's Lieberman said that the market has rallied through refunding periods in the past and is acting as if it may do the same this week.
"The near-term outlook on the bond is positive," he said.
The first of the Treasury's refunding auctions gets underway today. Dealers will absorb a mountain of new three- and 10-year notes and 30-year bonds, as the Treasury auctions off a record $38.6 billion in new coupons.
Dealers overwhelmingly agree that the bond will be the star performer this week. Those expectations spurred selling of two- and 10-year notes for the bond yesterday.
In when-issued trading, the new 30-year bond hovered around 6.40% and attracted strong demand. Traders said the issue is likely to offer a six of greater basis-point spread for investors looking to roll into the new issue at Thursday's bond auction.
Tony Crescenzi, head fixed-income trader at Miller, Tabak, Hirsch & Co., said that buying interest was directed almost exclusively at the long end of the curve yesterday and that most pre-auction positioning had also taken place at the long end.
"The bond auction is setting up to go very well," Crescenzi said. "Given the way the current issue is performing, all eyes will be on how the bond does at the auction."
Dealers reported decent interest in the 10-year note late yesterday. The risk, however, is that buyers will become less enthusiastic about the issue because of spread trades that favor the 30-year.
Interest in the three-year note was tepid at best late yesterday as the real money was focused on longer-dated paper and because of the flattening of the yield curve.
In futures, the September contract ended up 22/32 to 115.31.
In the cash markets, the 4 1/4% two-year note was quoted late yesterday up 2/32 at 100.11-100.12 to yield 4.05%; the 5 1/4% five-year note ended up 4/32 at 100.18-100.20 to yield 5.10%; the 6 1/4% 10-year note was up 9/32 at 103.08-103.10 to yield 5.79%; and the 7 1/8% 30-year bond was up 23/32 at 108.18-108.20 to yield 6.46%.
In when-issued trading, the new three-year note ended at 4.46%, the 10-year at 5.76%, and the 30-year bond ended at 6.40%.
The three-month Treasury bill was down two basis points at 3.06%; the six-month bill was down four basis points at 3.23%; and the year bill was down three basis points at 3.45%.Treasury Market Yields Prev. Prev. Monday Week Month3-Month Bill 3.06 3.11 3.066-Month Bill 3.23 3.29 3.191-Year Bill 3.45 3.55 3.372-Year Note 4.05 4.18 3.953-Year Note 4.34 4.47 4.275-Year Note 5.10 5.20 4.987-Year Note 5.41 5.48 5.3510-Year Note 5.79 5.83 5.7230-Year Bond 6.46 6.55 6.62Source: Cantor, Fitzgerald/Telerate