A weak Treasury auction and unfriendly inflation news hacked more than 3/4 point off the government s long bond yesterday, while municipals, though braised, suffered less.
"I guess it could be worse," one municipal trader said of the descent of the U.S. long bond following the Treasury's auction of 30 1/4-year bonds. "It's not just a free fall. We just seem to have come down a point and now we're kind of sitting." At midafternoon, the trader judged that municipals were down roughly 1/2 point. While tax-exempts are currently "in pretty good shape" relative to Treasuries, the trader said that things could change.
"Sometimes, it takes two days of bad data in the Treasury market before it shows up over here," he said.
In light secondary activity yesterday, yields on high-grade issues rose five basis points, while dollar bonds dropped 3/8 to 1/2 point, a municipal analyst said. In debt futures, the September municipal contract closed down nearly 1/2 point at 90. Yesterday's September MOB spread was negative 386 compared with negative 397 on Wednesday.
Observed George D. Friedlander, managing director at Smith Barney: "Municipals have settled into a range where they're simply less volatile in both directions than Treasuries, which is the norm."
Back in late March and early April, municipals exhibited more volatility than governments due to fear of redemptions from municipal bond funds, he said.
Retail demand and the scarcity of new municipal supply are also helping to keep a lid on volatility, Friedlander said. In a market driven by individual investors such as is the case with municipals now, higher interest rates attract retail buyers in search of higher yield, Friedlander said. That in turn helps to mute the increase in municipal rates.
While a stronger-than-expected producer price index report for July weakened the bond market early on, the 7.59% yield on yesterday's 30 1/4-year bond auction defied expectations for a 7.55% yield and sent Treasuries sharply lower.
PPI, the first of this week's two key inflation reports, posted a 0.5% rise overall in July and a 0.1% rise in the core rate, which excludes food and energy prices.
Robert Giordano, chief economist at Goldman, Sachs & Co., cited higher energy and coffee prices as factors contributing to the rise in the overall PPI rate. Higher energy prices stem from the higher crude oil prices seen in late spring and early summer, while the rise in coffee prices results from a frost in Brazil, the world's largest coffee producer, Giordano said.
"The way I interpret this overall, [is that] underlying inflation pressures remain quite subdued," the economist said. Despite that, Giordano thinks yesterday's PPI report contains some news worrisome enough to knock an undecided Federal Reserve off the fence. Until yesterday's figures, the economist thought the Fed would refrain from tightening monetary policy, but he now sees an increased likelihood of a rate increase emanating from next Tuesday's FOMC meeting. He sees a 25 basis point rise in the federal funds rate only.
Of particular concern are prices of intermediate mate. rials, which posted a 0.4% rise last month.
Though most of that jump has been confined to the building and auto sectors, it could presage bigger jumps in finished goods prices in the coming months, Giordano said. "I think it's probably a bit of a worry sign," he said.
The economist also pointed to yesterday's retail sales figures. Retail sales dipped 0.1% in July, while the June figure was revised to reflect an 0.8% gain, rather than the 0.6% gain originally reported.
"I think what it says is that consumer spending had not tailed off as much it had previously appeared in the numbers," he said. Giordano said it also appears that the buildup in second-quarter inventories was not as great as had been thought.
"I think the Federal Reserve could have been unnerved by today's numbers," Giordano said.
While signs of price increases at the intermediate stages of production coupled with a lack of clear slowing of economic activity point to a fed funds increase this week, it's not a certainty, he said.
"I still think it's a close call," Giordano said.
As for today's consumer price index, Giordano sees a 0.3% rise in both the overall and core rates.
Turning to next week's new-issue slate, a $700 million California deal on Wednesday dominates the competitive calendar. On the negotiated side. the market is expecting $329 million of Massachusetts Housing Finance Agency insured rental housing bonds through Lehman Brothers. The bonds are AMBAC-insured. Also next week, the New York State Dormitory Authority is expected to sell $250 million of revenue bonds through Bear, Steams & Co.
In other news yesterday, the 30-day supply of municipal bonds totaled $3.52 billion, down $423 million from Wednesday. That comprises $2.43 billion of competitive bonds, down $336.7 million from Wednesday, and $1.09 billion of negotiated bonds, down $86.3 million from yesterday.
Standard & Poor's Blue List of municipal bonds was down $4.5 million yesterday to $1.84 billion.
