Bond buyers are in short supply this week as a deluge of new debt flows into the Treasury market.
Governments ended mostly higher yesterday with the short end coming under pressure from supply-related concensus and the longer maturities moving higher as players pushed money out on the yield curve.
The 30-year bond ended up more than 3/8 of a point, to yield 7.51%, while the current two-year note closed unchanged on the day at a yield of 6.10%. Pressure on the bond market comes as primary dealers prepare to absorb $28.25 billion of new supply as part of the Treasury's monthly note sales. Complicating this week's market activity is the fact that the auctions come as bond investors are adjusting to the likelihood that the central bank will tighten monetary policy sooner than previously expected, observers said.
Short-dated Treasuries continued to take the brunt of selling as accounts moved money to other parts of the yield curve ahead of what many see as an imminent Federal Reserve rate increase. By contrast, longer-dated governments outperformed the shorter maturities because investors believe the long bond has the most to gain. from tighter monetary policy.
"A pre-auction cheapening of the two- and five-year Treasuries scheduled for sale has already commenced," said Matthew Alexy, senior market strategist at CS First Boston Corp.
Similarly, activity in the corporate bond market ground to a halt as underwriters and investors remained curious as to how the fixed-income markets will manage the upcoming Treasury supply. Players are nervous about the large amount of debt hitting the market and the kind of impact the supply will have on the corporate market.
Fed chairman Alan Greenspan, in his semiannual Humphrey-Hawkins testimony last week before the Senate Banking Committee, indicated that the central bank is still concerned over the pace of economic growth, inflation, and the weak U.S. dollar. Bond market players took the comments to mean that the Fed will again raise rates.
Against that backdrop, dealers are attempting to build a concession into the market ahead of the note sales. Participants said that with the Fed in a tightening mode, the when-issued notes are a bit rich for some investors' tastes.
A head governments trader said building a concession into the short end, particularly the when-issued two- and five-year notes, is crucial to the market's ability to absorb the new supply and distribute it afterward.
The coupon yield curve flattened further Monday with the help of a healthy performance by long-term securities. The yield spread between the 30-year bond and the two-year note narrowed to 142 basis points yesterday, from 146 late Friday.
Market players remain mixed on whether the yield curve's flattening trend will continue. Most agree that while the note auctions and concerns over tighter monetary policy are currently placing downward pressure on short-term securities, pressure will start hitting the long end of the curve soon. Expectations for higher long-term yields reflect the belief that the market will have a difficult time absorbing the upcoming refunding package.
Fixed-income market participants are setting their sights on the August refunding, when the market will absorb more than $40 billion of new Treasury debt. The upcoming refunding includes a 30-year bond offering.
"The market is entering into a time when supply will come on like a storm," a trader said. "Dealers will have to underwrite a huge amount of debt which spans the maturity spectrum. All this while the Fed is threatening to tighten."
The trader said that a common approach to a refunding is to purchase the two- and five-year notes at auctions and set up short positions in the 10- and 30-year issues to hedge those long positions and set up for the refunding sales. But with a potentially strong employment report coming out before the refunding auctions in early August, the trader said dealer positioning is likely to be less predictable.
Later in the week, fixed-income professionals will get their first comprehensive look at the economy' s performance in the second quarter as the Commerce Department releases its latest reading on gross domestic product. Economists polled by The Bond Buyer generally expect the release to show that the economy grew 3.6% in the second quarter.
The wild card this week will be the U.S. dollar's performance in global currency markets. The greenback gained considerable ground last week as Treasury and Bundesbank officials suggested they would like to see the currency appreciate in value.
The dollar also got some mileage out of Greenspan's congressional testimony last week. Greenspan mentioned the dollar as one of the Fed's major concerns about the economy, suggesting rates are headed higher soon.
"The argument for a near-tenn tightening on Fed monetary policy has been revitalized as a result of chairman Greenspan's expressed concern about the recent slide in the dollar, and its potential connections to inflation," said Steven Ricchiuto, chief economist at Barclays de Zoete Wedd Securities Inc.
Corporate bond spreads Waded tightly yesterday as a lack of supply drained the market of liquidity. Investment-grade issues generally ended unchanged, while high-yield bonds generally improved by between 1/8 and 1/4 of a point.
In the futures market, the September bond contract ended up 12/32 at 103.02.
In the cash markets, the 6% two-year note was quoted late Monday unchanged at 99.25-99.26 to yield 6.10%. The 6 3/4% five-year note ended up 3/32 at 99.13-99.15 to yield 6.87%. The 7 1/4% 10-year note ended up 8/32 at 99.31-99.03 to yield 7.23%. The 6 1/4% 30-year bond ended up 13/32 at 84.31-85.03 to yield 7.51%.
The three-month Treasury bill ended unchanged at 4.46%. The six-month bill closed unchanged at 4.94%. The year bill also ended unchanged at 5.52%.Treasury Market Yields Prev. Prev. Monday Week Month 3-Month Bill 4.46 4.33 4.23 6-Month Bill 4.94 4.80 4.76 1-Year Bill 5.52 5.29 5.36 2-Year Note 6.10 5.96 6.03 3-Year Note 6.40 6.28 6.31 5-Year Note 6.87 6.77 6.78 7-Year Note 7.03 6.96 6,81 10-Year Note 7.23 7.18 7.15 30-Year Bond 7.51 7.50 7.45
Source: Cantor, Fitzgerald/Telerate