Treasury bonds plunged yesterday as weak demand for new government paper dashed hopes for a successful end to the August refunding.
Bond investors dumped securities after news that the Treasury's 30 1/4-year bond auction, the third and final leg of the quarterly refunding, met with considerably weaker demand than market participants expected.
Lack of demand for the issue showed how wary investors are of buying new long-dated securities ahead of the release of a key report on inflation and a possible tightening of monetary policy.
"It was a bad auction, and I don't think a whole lot of this auction has been distributed," said Michael Strauss, chief economist at Yamaichi International Inc. "The Street holds it, and retail has not been participating in these auctions." The Treasury sold $11 billion of 30 1/4-year bonds at an average yield of 7.56%, and securities were awarded at bids as high as 7.59%. Bond dealers widely expected the issue to come at a 7.55% average yield with a possible tail back to 7.56%.
Further clouding the auction results was a general lack of interest in the new long bonds. There was only $21.6 billion of bids entered, which put the bid-to-cover ratio at a dismal 1.96 to 1.
Lack of investor interest in the refunding left dealers holding large amounts of Treasury paper, much of it now at a loss, dealers said. Amid signs that the U.S. economy continues to navigate a steady growth path and that the Federal Reserve is poised to raise short-term interest rates again, retail investors steered clear of yesterday's bond auction. Wall Street observers believe accounts avoided bidding aggressively in hopes of buying the issue cheaper once the central bank tightens credit.
In addition, analysts attributed the poor auction to a combination of disappointment over the economic reports released yesterday and nervousness ahead of economic reports due this morning.
Late afternoon short-covering lifted the Treasury market from its worst levels of the day, but players agreed that the trend in coming sessions would be lower, barring unexpected support from the consumer price index due today.
The active 30-year bond closed down more than 3/4 of a point, to yield 7.64%, while the two-year note ended down more than 1/8 of a point, to yield 6.24%.
The market sold off yesterday morning following the release of the retail sales report. The Commerce Department reported a 0.2% decline in sales for July. The bond market, however, focused on upward revisions in retail sales figures for May and June. Sales for June were revised to show a gain of 0.8% from the 0.6% initially reported. May sales were revised to unchanged from the previously reported 0.4% decline.
Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc., said that the retail sales figures, particularly the revisions to prior months, supported the view that despite higher interest rates and weaker consumer sentiment, consumers continue to spend. "The bond market did not like the retail sales numbers," he said.
"These revisions show that the inventory buildup in the second-quarter gross domestic product report was not as large, nor was consumption as weak, as was originally estimated," Wesbury said.
The producer price index, on the other hand, was a mixed bag that should not alter the Federal Reserve's outlook on the economy or inflation. The Labor Department yesterday reported an unexpectedly large 0.5% increase in producer prices in July. Without food and energy items, producer prices were up 0.1%.
"The July data for retail sales and the PPI suggest that the economy has not been as weak as it appeared nor have inflationary pressures moderated," Wesbury said, noting that the Fed is still likely to raise rates on or Soon after Tuesday.
Market observers generally expect the Fed to raise short-term interest rates at next week's meeting of the Federal Open Market Committee. Most generally expect the Fed to raise its federal funds rate target by at least 25 basis points to 3.75%. However, a growing number of market participants are calling for a 50-basis-point move, which they say would help calm nerves in the bond market.
Selling pressure yesterday was heaviest at the long end of the market, which is coming to grips with talk that the Fed may only move by 25 basis points. A quarter-point hike in the funds rate would increase uncertainty in the market because it would leave the prospect of additional tightening hanging over, analysts said.
"A 50-basis-point move would help instill confidence and help the market trade better," said Robert Brusca, chief economist at Nikko Securities Co. At this point in the business cycle, "it's better to raise rates more than less."
Today's consumer price index report will figure prominently in the Fed's deliberations about monetary policy next week, market observers said.
Economists polled by The Bond Buyer generally expect a 0.3% increase in both the overall report and the core rate.
Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp., expects the CPI to increase by 0.3%, including and excluding its food and energy components. Energy prices are expected to have increased, while food prices held steady, Schaja said, noting that the inflation figures continue to fit with her expectations that core CPI growth in 1994 will be slightly in excess of 3.0%.
In the futures market, the September bond contract ended down 26/32 at 102.02.
In the cash markets, the 6 1/8% two-year note was quoted late yesterday down 5/32 at 99.24-99.25 to yield 6.24%. The 6 7/8% five-year note ended down 11/32 at 99.14-99.16 to yield 6.99%. The 7 1/4% 10-year note ended down 18/32 at 99.06-99.10 to yield 7.34%. The 6 1/4% 30-year bond ended down 27/32 at 83.21-83.25 to yield 7.64%.
The three-month Treasury bill ended up one basis point at 4.43%. The six-month bill closed up five basis points at 5.09%. The year bill ended up four basis points at 5.56%.
The primary market for corporate securities ground to a halt yesterday as issuers and investors wondered how this week's deluge of government supply would affect the broader fixed-income markets.
With intermediate- and long-dated Treasuries feeling the weight of new supply, corporate debt issuers kept their offerings on the shelves. Also, few investors were willing to risk taking positions during the quarterly refunding and ahead of a possible Fed tightening next week.
In the secondary market for corporate securities yesterday, spreads of investment-grade issues widened by about 1/2 a point, while high-yield bonds generally held steady. Treasury Market Yields Prev. Prev. Thursday Week Month 3-Month Bill 4.43 4.42 4.35 6-Month Bill 5.09 4.88 4.85 1-Year Bill 5.56 5.33 5.33 2-Year Note 6.24 5.95 6.01 3-Year Note 6.60 6.23 6.36 5-Year Note 6.99 6.72 6.83 7-Year Note 7.17 6.33 7.02 10-Year Note 7.34 7.10 7.23 30-Year Bond 7.64 7.40 7.54 Source: Cantor, Fitzgerald/Telerate