The debate over the direction of the economy continued yesterday and the Treasury marked swayed with each retort.
The market saw both sides of recent ranges as the bulls and bears battled for supremacy and the 30-year bond ended up almost 3/4 of a point, to yield 5.94%. This was the lowest closing yield in six sessions for the benchmark bond.
Prices fell sharply in response to strong news on the economy through the morning, and then forged higher through the afternoon to erase some of the losses posted in recent trading sessions.
Despite the wild price swings which characterized the trading yesterday, Treasury issues failed to break out of the narrow ranges in which they have traded in recent sessions.
Prices plunged following the release of gross domestic product statistics, which suggested that a slow but sustainable recovery is underway. Pockets of strength in the GDP figures weighed on the minds of investors who are trying to get a handle on the direction of the U.S. economy and interest rates, prompting them to sell Treasuries.
But the market posted an impressive rebound as some participants bought securities on dips and others reacted to a central banker's prediction that fourth-quarter GDP could be weaker than expected.
Buyers emerged to take advantage of attractive buying opportunities brought on by price declines made through the morning. Interest was particularly brisk at the long end of the yield curve.
Federal Reserve governor Susan Phillips, testifying before the House Banking Committee, said she was encouraged by the GDP figures but cautioned that the fourth quarter could be slower. The comments prompted some short covering and allowed issues at the short and long ends of the curve to recoup early losses.
"Phillips" comments turned the market around at a very critical moment," said Anthony Karydakis, senior financial economist at First Chicago Corp. "They provided a boost for the market and made people feel more confident."
Market observers generally felt that Phillips' predictions were somewhat out of touch with the market's prevailing view that the economy will finish out the year strongly. However, the comments sparked a short-covering rally, which helped the market climb out of the hole it dug for itself during the morning sell-off.
"The end justified the means," said one head trader at a primary dealership. "Today's drop in prices was overdone and people needed an excuse to buy some paper back."
Another boon for Treasuries yesterday was the growing perception that the market has found a bottom. That notion grew out of the emergence of retail- and technically-dominated buying as the market moved higher. A prevailing strategy in the market has been to sell on upticks, but yesterday, accounts were purchasing securities on upward moves.
Tony Crescenzi, head fixed-income trader at Miller, Tabak, Hirsch & Co., said the market is trying to find a comfort zone where it can tolerate stronger economic growth. Investors are trying to warm up to the idea of 3% growth or higher in coming months as well as government-induced inflation as tax increases and health-care reform take effect, he said.
Traders reported significant hedge-fund buying of five- and 10-year notes yesterday, but they generally did not think the market will make a convincing move to the upside unless investors find reason in upcoming economic reports to do so.
"There's been some retail bottom-fishing but it's probably not enough to sustain prices ahead of other data coming out in the next couple weeks," Crescenzi said. "We need some more news on the economy to see where the market is going."
The GDP report did not alter the market's view of the economy. The Commerce Department reported that the U.S. economy grew at a moderate annual rate of 2.8% last quarter. The increase was in line with market expectations for better personal spending, business investment, and a rebound in outlays for housing. The implicit deflator was just 1.6%, underscoring the moderate trend in inflation.
Kenneth T. Mayland, chief economist at Society National Bank in Cleveland, said the report was consistent with the notion that the economy will end the year on a strong note. Mayland was particularly cheered by the 4.1% gain in personal spending and the 10.1% of surge in residential investment.
"These sectors keep moving right along and have given no signs of a slow down," Mayland said. "In light of the weak consumer confidence numbers, the GDP report looks good for the economy and not so good for the bond market."
The GDP figures also sparked a debate over the correlation between consumer confidence and spending, with some participants holding up yesterday's GDP figures as proof that there is little. Market analysts argued that despite a weak employment sector and a slew of reports that show consumer sentiment to be at all-time lows, spending has grown at a steady clip.
Raymond Stone, a managing partner at Stone & McCarthy Research Associates, said stepped-up consumption activity has resulted from low interest rates. "It's hard to conclude that consumers are not able to spend money when consumption figures have been up steadily in recent months," Stone said.
Looking ahead, market observers said the third-quarter GDP figures bode well for growth in the fourth quarter, a development that could pose considerable problems for the Treasury market. They believe the drawdown in inventories in recent months will necessitate more production as manufacturers order goods to replenish stocks.
Stone believes that recent buoyance in the auto sector of the economy will boost fourth-quarter GDP by between 1% to 1.5%. "All indications from this report and others point toward GDP growth of about 4% in the fourth quarter," he said.
In good news for the market, a new survey shows that small-business owners in the U.S., swamped by a flat economy and prospects for higher taxes and the new Clinton Administration health plan, are more gloomy over current economic conditions than they were in the 1980s.
According to the Dun & Bradstreet survey, just 38% of small-business managers said they are optimistic about the outlook for their businesses in the next 12 to 18 months, down from 51% a year ago. The previous low in optimism was 44% recorded in 1982, the deepest part of a long recession.
The survey, which is a sample measuring small-business optimism with the presidents and owners of 5,000 businesses with sales under $12 million, finds that 33% of small-business owners call themselves pessimistic, the highest percentage in the survey's 13-year history.
The Fed reported its weekly money supply figures late yesterday. In the week ended Oct. 18, the central bank reported a $4.5 billion increase in M2, a $1.1 billion decline in M2, and a $900 million slide in M3.
The Treasury also reported September budget surplus of $8.3 billion, leaving the fiscal 1993 deficit at $254.9 billion. The figures were in line with market expectations.
In futures, the September contract ended up 15/32 to 118.31
In the cash markets, the 3 7/8% two-year note was quoted late yesterday up 2/32 at 99.26-99.27 to yield 3.95%. The 4 3/4% five-year note ended up 2/32 at 99.23-99.25 to yield 4.80%. The 5 3/4% 10-year note was up 15/32 at 102.25-102.29 to yield 5.49%.Treasury Market Yields Prev. Prev. Thursday Week Month3-Month Bill 3.04 3.05 2.966-Month Bill 3.18 3.15 3.121-Year Bill 3.33 3.27 3.352-Year Note 3.95 3.84 3.853-Year Note 4.19 4.12 4.165-Year Note 4.80 4.70 4.767-Year note 4.95 4.89 4.9510-Year Note 4.36 5.32 5.3730-Year Bond 5.94 5.91 6.01Source: Cantor, Fitzgerald/Telerate