Treasury securities prices ended with big losses yesterday after selling off on the threat of higher oil prices and a series of stronger-than-expected economic indicators.
Late yesterday, the 30-year bond was off more than a point and yielded 7.91%, while short-term notes were down 1/4 to 3/8 point.
The price slide began on a report in yesterday's Wall Street Journal that said Saudi Arabia had shifted its position and now favors higher oil prices.
Later in the session, the Treasury market deteriorated further in response to a string of healthy economic reports, including April existing home sales, May consumer confidence, and mid-May car sales.
"The market's been for sale since the opening bell," a Treasury coupon trader said.
Traders said the bulk of the price decline came in response to the story about Saudi Arabia's favoring higher oil prices and to the market's worries about what such increases in oil prices would mean for inflation.
In recent years, the Saudis have been a voice of moderation in the Organization of Petroleum Exporting Countries.
The Journal attributed Saudi Arabia's change of heart to its own financial needs, pressure put on it by Iran, and a European proposal to raise taxes on oil.
The Journal estimated that the shift by Saudi Arabia could add $3 to the price of a barrel of crude oil.
"It's disconcerting for the bond market to see Saudi Arabia willing to align itself with those countries that have sought higher prices," Mr. McCarthy said.
"It wouldn't take long for it to translate into increases in gasoline prices, home heating oil prices, and consumer energy prices in general," he added. "And over time, it gradually gets reflected the prices of virtually everything, because energy is a cost of production in almost every good and service provided in this country."
Mr. McCarthy added that recently consumers have been resisting higher prices, a stance that could limit the extent to which OPEC price hikes are passed on.
The direct impact of such an oil hike on U.S. consumer prices would be relatively small, said Kathryn Kobe, an economist at Joel Popkin & Co., an economic consulting firm in Washington, D.C.
She calculated the consumer price index would rise two-tenths of a percentage point if crude oil rose $3 a barrel. But secondary impacts, like an increase in the cost of air travel as airlines passed on higher fuel costs, would put additional upward pressure on the inflation measure, Ms. Kobe said.
"For people who were hoping for inflation to get down to 3%, this is not good news," she added.
Traders conceded that higher oil prices would be bad news for U.S. consumers and for U.S. fixed-income markets, but many were skeptical that OPEC had the discipline to achieve those higher prices.
"It's not clear these prices will stick," said the head of a government trading desk. "OPEC members are notorious for cheating on quotas."
Ms. Kobe said, though, that OPEC might have an easier time keeping production under control at this time since Kuwait is still handicapped by the damage it incurred during the war and Iraq is still not allowed to export oil.
The key U.S. oil futures contract, the July West Texas Intermediate contract, jumped $1.06 to close at $22 a barrel yesterday.
Traders said late yesterday that the session's price losses might be just the start of the Treasury market's troubles.
Retail accounts dumped securities on dealers yesterday, leaving Wall Street firms with even bigger long positions than they had had before, a coupon trader said.
"Now the Street is weighted down with paper and there are no buyers," the trader said. "And we popped through a few technical levels, which turned the technicians negative."
The head of a trading desk was even more pessimistic, maintaining that the party's over.
"The real selling hasn't started yet," according to the desk head, who said investors put off selling securities at a loss yesterday because they hoped something would push prices higher later this week.
"They think they'll have a rally to sell into," he said. "They're hoping for a good money supply number, but I think they'll be forced out earlier than that."
Today's only indicator, April durable goods, is a number that often surprises the market. The consensus forecast is for a 0.5% increase.
All of yesterday's economic reports supported the notion that the economic recovery is slowly getting underway.
The Conference Board said its measure of consumer sentiment rose to 71.6% in May, up 6.5 points from the revised 65.1% reading in April.
Fabian Linden, director of the Board's consumer research center, said the improvement in the index in recent months "appears to leave little doubt that the economy is at long last recovering."
The improvement that occurred in mid-May auto sales seemed to support that view.
With most of the car companies having reported their sales, economists estimated sales were running at an annual pace of 6.7 million in the May 11-May 20 period, far above the 6.1 million rate economists expected.
The 6.7 million also represents a huge improvement over the 5.7 million sales rate in early May and the 5.6 million pace in the same period last year.
Car sales are "coming around slowly," said Diane Swonk, a senior regional economist at the First National Bank of Chicago. "If this was a typical recovery, we'd be seeing around eight million units."
The jump in mid-May "was a much needed boost given how weak the first 10 days were," Ms. Swonk added.
She said the improvement in the light truck category was even more encouraging, since the profit margin on light trucks is greater for the car companies.
Earlier, the National Association of Realtors reported that sales of existing homes came in at a 3.5 million annual rate in April, down 0.3% from the 3.51 million pace in March, but up 6% from the sales rate last April. Traders said the relatively stable sales pace was notable because it seemed to contradict the 17% plunge in April housing starts reported last week.
The June bond futures contract closed 1-3/16 lower at 99-21/32.
In the cash market, the 30-year 8% bond was 1-1/16 lower, at 100-28/32-101, to yield 7.91%.
The 7-1/2% 10-year note fell 11/16, to 100-10/32-100-14/32, to yield 7.43%.
The three-year 5-7/8% note was down 3/16, at 99-31/32-101-1/32, to yield 5.86%.
In when-issued trading, the 5-1/8% two-year note was 5/32 lower, at 99-19UF32-99-20/32, to yield 5.32%, and the five-year 6-3/4% note was off 11/32, at 99-27/32-99-29/32, to yield 6.77%.
Rates on Treasury bills were higher, with the three-month bill up for basis points at 3.73%, the six-month bill up eight basis points at 3.87%, and the year bill nine basis points higher at 4.09%.