Most Treasury prices posted small losses yesterday after a good producer price report failed to buoy the bond market.
Late yesterday, note prices were down about 1/8 point. The long bond, which performed better than the rest of the market, was up almost 1/8 point to yield 6.61%.
June producer prices fell 0.3%, and the core rate, excluding food and energy costs, was down 0.1%.
The report shows "there's little evidence of a growing inflation problem," said Carol Stone, a senior economist at Nomura Securities International. "The inflation scare we had earlier was just that, and it's dissipating rapidly."
Analysts said even though the inflation news was favorable for fixed-income securities, Treasury prices had nowhere to go because the market had already accounted for a good number as it rallied in recent sessions.
"I guess the number was close enough to expectations that people thought it might be a good time to sell, to take some profits," said Cary Leahey, a senior economist at Lehman Brothers.
Leahey said prices moved a little lower when yesterday afternoon's Johnson Redbook report showed department store sales during the first week of July were up 2.4% from the same period in June.
"The market got a little nervous and sold off on that," Leahy said, but noted that the Johnson Redbook report does not seem to be as accurate a predictor of retail sales as it once was.
Traders said the most interesting feature of yesterday's trading was the flattening in the yield curve as the long bond outperformed the rest of the market. Late yesterday, the 30-year bond was yielding 261 basis points more than the two-year note, down from 267 late Monday.
There were reports of selling at the front end, including one trade in which an account sold a huge quantity of one-, two-, and three-year securities and bought bonds. A Chicago bond salesman said interest in bonds was also coming from Europe.
Kevin Logan, chief economist at Swiss Bank Corp., said the flattening was not surprising. The short end's upside is limited because it is unlikely the Federal Reserve will ease monetary policy, so investors are moving funds into longer-term securities to get better yields, he said.
Logan said he expects the curve to continue to flatten, but warned that the move could be bumpy.
"Starting Thursday, the House-Senate Conference Committee will meet" to try to reconcile the two versions of the budget package, he said. "Maybe we won't like what we hear, in which case the bond will back up and the curve will steepen again."
Traders said the move out of the short end may also reflect participants' nervousness that short-term paper is more vulnerable to good news on the economy because signs of strength would reawaken worries about a Fed tightening.
"We're fighting the next battle, which is expecting the economic conditions to improve," a note trader said. "So maybe it's back to the flattening trade."
Traders said yesterday's price declines suggested the Treasury market might be vulnerable to more losses in the days ahead.
A coupon trader said the market seemed tired and predicted the front end will take it badly if some of the stronger predictions for today's retail sales reports turn out to be true.
The consensus forecast calls for a 0.4% increase in June retail sales, but some economists are forecasting gains of as much as 0.8%.
Also today, June consumer prices are expected to be up 0.1% and the core rate, excluding food and energy, is expected to rise 0.2%. Early-July car sales are expected to moderate to a 6.7 million annual sales rate from the 7.7 million pace in late June.
The decline in June producer prices follows the flat reading in the May index. The two months of moderation were reassuring to the bond market after the outsized gains in both inflation indexes seen during the first four months of this year.
As expected, the June producer price report showed big slides in tobacco, food and energy prices.
Tobacco prices fell 5.9% last month, food was down 0.9%, and energy was off 0.5%.
Excluding the big drop in tobacco prices, the June producer price index would have been down 0.1% and the core rate would have been up 0.2%.
Peter Greenbaum, an economist at Smith Barney Harris Upham & Co., said producer prices rose 1.5% in the year ending in June, or 1.7% if the June tobacco decline is excluded.
Given that the producer price index has been running at or near 2% so far this year, the June report shows a "breakdown" in the index, he said.
"Whether or not it will be sustained, given the supply disruptions caused by the midwestern floods, is another issue," Greenbaum said.
He said the estimates of crop damage so far suggest the flooding will have "a rather limited impact" on crop prices. Greenbaum expects the disaster to result in just a couple of months of higher price numbers.
The September bond futures contract closed 2/32 higher at 114 27/32.
In the cash market, the 7 1/8% 30-year bond was 3/32 higher, at 106 18/32-106 20/32, to yield 6.61 %.
The 6 1/4% 10-year note fell 3/32, to 103 21/32-103 23/32, to yield 5.73%.
The three-year 4 1/4% note was down 3/32, at 99 25/32-99 27/32, to yield 4.30%.
Rates on Treasury bills were mixed, with the three-month bill down two basis points at 3.04%, the six-month bill up one basis point at 3.15%, and the year bill three basis points higher at 3.30%.Treasury Market Yields Prev. Prev. Tuesday Week Month3-Month Bill 3.08 3.02 3.106-Month Bill 3.22 3.20 3.231-Year Bill 3.40 3.42 3.452-Year Note 4.00 3.99 4.053-Year Note 4.30 4.31 4.435-Year Note 5.00 5.03 5.177-Year Note 5.37 5.42 5.5610-Year Note 5.73 5.77 5.9330-Year Bond 6.61 6.67 6.81Source: Cantor, Fitzgerald/Telerate