Treasury prices rallied sharply yesterday morning on good inflation news and added to those gains when weak money supply statistics were released late in the day.
The 30-year bond closed a full point higher, where it yielded 7.91%, its lowest closing level since late December 1989.
The negligible increase in producer prices during August showed inflationary pressures are under control, which leaves the path clear for another Fed easing, and the big declines in the monetary aggregates give the Fed another motive to move, economists said.
The Labor Department reported that August producer prices rose 0.2%, as did the core rate, excluding food and energy prices. The consensus forecast was for a 0.3% increase in both measures.
In July, wholesale prices were down 0.2% and the core rate was up 0.2%.
"There was a lot of fear out there that we'd get some really nasty
Treasury Market Yields
Thursday Week Month
3-Month Bill 5.32 5.48 5.43
6-Month Bill 5.39 5.60 5.55
1-Year Bill 5.47 5.71 5.61
2-Year Note 6.11 6.32 6.27
3-Year Note 6.42 6.68 6.68
4-Year Note 6.60 6.79 6.84
5-Year Note 7.08 7.34 7.33
7-Year Note 7.42 7.65 7.64
10-Year Note 7.62 7.83 7.82
20-Year Bond 7.86 8.04 8.05
30-Year Bond 7.91 8.09 8.08
Source: Cantor, Fitzgerald/Telerate
readings and we didn't," said Matthew Alexy, a money market economist at Deutsche Bank Government Securities.
The 0.2% increase in August "on both the core and the aggregate is a good sign that inflation is still pretty well under control at the wholesale level," said Ian Borsook, a senior economist at Merrill Lynch.
The August gain was led by a 1.8% jump in energy prices, but Mr. Borsook said that surge was not likely to continue. And he noted that the 0.4% drop in food prices marked the third monthly decrease in that category.
Much of the 0.2% gain in the core rate was due to higher car and tobacco prices. Mr. Alexy pointed out that if auto sales remain weak, those car price increase are likely to be offset at the consumer level by manufacturers' rebates.
The market got another slug of good news late in the day when the New York Fed announced big declines in the three monetary aggregates.
A spokesman for the New York Fed reported the nation's M1 money supply fell $2.6 billion to $867.1 billion in the week ended Sept. 2; the broader M2 aggregate plunged $9.7 billion, to $3.4 trillion; and M3 dropped $10.8 billion, to $4.1 trillion, in the same period.
The decrease in M2, the most closely watched of the three measures, more than reversed the $6.4 billion gain posted last week.
The weekly decline also means M2 is once more below the target range the Fed has set for its growth, although the monthly M2 measure is still within that target range.
"There are plenty of reasons for the Fed to ease and the PPI and money supply growth are two more reasons," said Doug Schindewolf, a money market economist at Smith Barney, Harris Upham & Co.
Still, Mr. Schindewolf said he was not convinced the Fed will move today.
"The comments by Fed officials recently haven't indicated that they're poised to ease," he said.
He also noted that today's indicators -- August consumer prices and retail sales -- don't give the Fed much new information about the pivotal consideration behind monetary policy right now, the speed at which the economy is recovering.
Kevin Flanagan, an economist at Dean Witter Reynolds Inc., said a decline in retail sales and a modest increase in consumer prices might allow the Fed to ease. But he was also doubful about whether the Fed would move today.
"They've hardly ever eased off CPI, it's just not their style," Mr. Flanagan said. "I think they want more information before they go."
He cited Fed Governor Wayne Angell's remarks yesterday about the importance of price stability. "Some Fed officials on the policy-making committee may not be ready to go here."
While economists sounded a note of caution, the price action yesterday showed traders and investors look for a Fed move sometime today.
Treasury securities "traded extraordinarily well given all the selling we saw," a government coupon trader said, adding that many people had taken advantage of the rally to book some profits.
The Treasury market did not even flinch when the Fed stayed out of the market at Fed time, since most participants expected the Fed would wait to see today's numbers.
Traders said some technical signals also pointed to further improvements in Treasury prices.
Karen Gibbs, a senior futures analyst at Dean Witter Reynolds, said the December bond futures contract is very close to its all-time high of 98 20/32.
The December contract closed yesterday at 98 17/32, up 23/32.
"This market has broken out to the upside, expecting a Fed ease," Ms. Gibbs said. "If the Fed does ease, we can make new contract highs."
On the other hand, Andrew Gold, a first vice president at Lehman Brothers, said the overwhelming optimism among bond market participants suggested the market might be nearing a top.
"Cash levels in bond funds are very low, so there's really no liquidity," Mr. Gold said.
He also cited the heavy amount of corporate issuance this week. "Typically you see increasing levels of new-issue activity near a top in any kind of market."
In the cash market, the 30-year 8 1/8 bond was 1 1/32 higher, at 10 27/32-102 11/32, to yield 7.91%.
The 7 7/8% 10-year note rose 23/32, to 101 19/32-101 23/32, to yield 7.62%.
The three-year 6 7/8% note was up 9/32, at 101 4/32-101 6/32, to yield 6.42%.