U.S. Treasury securities showed surprising strength yesterday in early trading when a strong durable goods report failed to spark selling, but prices faltered later in the day when players realized they paid too much at the Treasury's five-year note auction.
Treasury cash and futures prices dipped but then recovered quickly in the morning after the Commerce Department reported that manufacturers' new orders for durable goods rose 6% in August. The consensus forecast was for a gain of about 4%.
Futures prices added to their gains just past noon when December bond futures broke through resistance from Tuesday, trading up 23/32 at 99.14. The Knight-Ridder news service reported that the December contract's move above the 99 9/32 support point triggered additional technical buying and set off buy-stops.
The December Treasury bond futures contract closed up 14/32 at 99.05.
Traders in the cash market reacted negatively immediately upon seeing the higher-than-expected durable goods number, but calmed down when it became clear that much of the strength came from seasonal transportation orders. Excluding transportation equipment shipments and new orders, the overall number was in line with expectations: up 2.3%.
The overall number indicates that orders for durables are still rising, but at a slower growth rate this quarter than last.
A note trader for a primary dealer pointed out that durable goods orders "can be erratic and zigzag," so traders "have to smooth out the trend" when considering the numbers. Still, the trader said, "if the market wanted to go down, this could have been an excuse."
The benchmark 30-year Treasury bond closed up 10/32 yesterday, to yield 7.81%.
Prices rose across the yield curve, with the long bond up almost half a point at midmorning, despite the Federal Reserve's decision not to raise interest rates Tuesday and the strong durable goods figures.
In fact, the trader said, most of yesterday's selling was actually profit-taking off of curve trades, with people running from the long end and holding up the short end. "So the market really didn't go down when it could have," the trader said.
Philip Braverman, senior vice president and chief economist with DKB Securities Corp., said yesterday that the market was showing a better tone "in that it took bad news in its stride and then some."
The fact that the market didn't go down on the durable goods figures gave the players a lift, Braverman said, adding, "two-year [notes] and longer are reasonably priced for a Fed firming that hasn't materialized."
Right before the Treasury sold $11 billion of five-year notes in a Dutch auction yesterday that resulted in a yield of 7.18%, Braverman said the market's better tone would help the auction, and he was proved correct.
The five-year note auction yesterday drew the highest yield since August 1991. Analysts said bidding was strong, with a bid-to-cover ratio of 3.29 to 1 compared with a 2.73-to-1 average ratio in the last 12 auctions of five-year notes. Heavy short-covering was said to have helped bring down the yield.
A total of $36.22 billion notes were bid for, $906 million of that in noncompetitive bids. The lowest bid yielded 7% and the yield on the median bid was 7.17%, according to the Treasury.
Traders on Tuesday feared that weak demand for the day's two-year note auction would make the five-year a more difficult issue for the Treasury to sell.
Tuesday's auction of $17.25 billion of two-year notes produced an average yield of 6.55%, also a high for the note since July 1991. The two-year auction was underbid, at a 2.55 to 1 bid-tocover ratio, compared with a 2.68 to 1 12-month average, largely due to traders' uncertainty over whether the Federal Open Market Committee would announce a tightening.
By mid-afternoon, however, the market realized that "people panicked and paid too much" at the five-year auction, according to the head of a Treasuries trading desk. After the auction, the five-year was trading to yield 7.20%, he said.
The five-year results set a tone that had an impact across the curve, the desk head said. "And a lot of stuff is being unwound because the Fed didn't move," he said.
Braverman said economic fundamentals were showing some improvement, as evidenced in the United States' trade talks with Japan, which added to the market's improved spirits yesterday. But the desk head said the market feared that Japanese bond traders "might know something we don't," which added to the mid-afternoon pessimism.
U.S. trade representative Mickey Kantor and Japanese trade minister Ryutaro Hashimoto said yesterday they will continue talks until the Friday deadline in an effort to keep the United States from imposing trade sanctions against Japan.
The dollar was up against the Japanese yen yesterday, closing at 98.85 yen on the day.
Against other currencies, the dollar also rose, partly because of flight-to-quality trading when the Mexican stock market plunged after the number two member of Mexico's ruling party was shot in an assassination attempt.
The note trader said market participants, most of whom did not believe the Fed would tighten Tuesday, are now waiting for September's economic reports to be released in October.
The market is focusing on the nonfarm jobs number on Oct. 7 and on the producer price index and on Oct. 13's capacity utilization report. Consensus is for a 220,000 jobs increase in September. Economists have not yet released capacity utilization estimates.
Growth in nonfarm jobs in August was lower than expected -- up 179,000 compared to July's 259,000 advance.
But when August jobs were reported on Sept. 2, players worried about inflationary cues sold into the PPI. Their fears were realized Sept. 9 when the PPI was reported up 0.6%, compared to consensus expectations for a 0.4% rise. The 30-year Treasury bond plummeted nearly 1 3/4 points that day on news that the August PPI represented the index's biggest gain since the 1.1% gain of October 1990.
Another big day for the market to watch will be Oct. 14, with the expected release of three important September indicators: the consumer price index, retail sales, and industrial production.
Last month's industrial production and capacity utilization numbers, both reported Sept. 16, really moved the market. Treasury prices plunged, with the 30-year shattering the 7.75% barrier, when the Fed reported that the nation's manufacturing plants operated at 84.7% of capacity, the highest level since April 1989. The Fed also reported that industrial production rose 0.7% in August, exceeding the forecast of a 0.5% gain.
On Tuesday, the long bond suffered even more when the Federal Open Market Committee meeting ended without a tightening announcement. The 30-year benchmark bond's price fell 1/2 point and its yield rose to 7.84%, the highest level since June 1992.
It is widely believed that the Fed will tighten before yearend, at its Nov. 15 FOMC meeting if not earlier in October.
The Commerce Department's report on Sept. 14 that August retail sales were up 0.8% came in as expected, however, and resulted in lackluster trading. As for last month's CPI, reported Sept. 13, fears of a wildly inflationary index were so prevalent that many players had hedged their positions. When the number proved to be fairly tame, up only 0.3% in August compared to expectations of a 0.4% rise, it set off a round of short-covering that pushed Treasury prices higher.
The 10-year Treasury note rose 1/8 yesterday to yield 7.57%. The seven-year note was up #1/16 to yield 7.40%, and the five-year edged #1116 higher to yield 7.20%.
The yield on the three-month bill was up 17 basis points to 4.61%. The yield on the six-month bill was down one basis point to 5.36%, and the yield on the one-year also shed one basis point to 5.85%.
Quarter end-related buying of bills by a few large market participants accounted for the rise in the three-month bill, according to Kathleen Camilli, chief economist at MFR Inc. Treasury Market Yields Previous Previous Week Month Wednesday 4.61 4.90 4.653-Month Bill 5.36 5.38 5.036-Month Bill 5.84 5.88 5.511-Year Bill 6.50 6.49 6.132-Year Bill 6.78 6.78 6.403-Year Bill 7.20 7.19 6.775-Year Bill 7.40 7.38 6.977-Year Note 7.57 7.55 7.1610-Year Note 7.81 7.80 7.4430-year Bond
Source: Cantor, Fitzgerad/Telerate