The 30-year Treasury bond plummeted nearly 13/4 points Friday on news of a 0.6% rise in the producer price index for August, the biggest gain since the 1.1% of October 1990.
Investors sold off on the larger-than-expected August number because it confirmed their growing inflation fears. Economists' consensus had been for a 0.4% rise.
The August core rate, which excludes food and energy prices, also rose more than expected, to 0.4%, the biggest increase since a 0.5% increase in January. Economists had called for a 0.2% increase.
The benchmark 30-year bond closed down more than 1 5/8 yesterday, to yield 7.70%
The long bond's tumble was accompanied by price drops across the board, with the 10-year note dropping more than a point before midday to yield 7.43% and the two-year down 9/32 to yield 6.33%.
T-bills also showed tremendous movement before midday, with the one-year trading up 12 basis points at 5.65% and the three-month up four basis points to yield 4.67%.
The bond market's slide was not helped by the dollar, which was trading as low as 99.10 Japanese yen and 1.5365 German marks before midday. David Munro, chief U.S. economist for High Frequency Economics, said Friday's inflation report contributed to the dollar's weakness. "The PPI is a hint of uncertainty about where the U.S. economy is headed," Munro said.
The dollar was also hurt by inconclusive trade talks with Japan about insurance reforms, procurement of health care products, and finished automobiles and auto parts, he said.
Come tomorrow, Treasury securities may be pummeled once again with the release of the August consumer price index, which economists see rising 0.3% or 0.4%.
Treasury trading will not move outside of its current levels, although "we think rates will keep moving higher," said Elias Bikhazi, vice president and financial economist at Deutsche Bank Securities Corp.
"Make no mistake about it, the August PPI statistics are as bad as they first appear," said a CS First Boston Inc. release. "Today's figures introduce evidence of the inflation uptick many fixed-income market participants have feared since the start of this year."
Bikhazi said he did not see CPI expectations changing because of the higher-than-expected PPI numbers.
The PPI is a stronger indicator of inflation to come than the CPI because the producer index tracks prices from crude materials through the intermediate stages of production to finished goods, according to economist Maria Fiorini Ramirez. The CPI reflects only current inflation and offers no clues about future inflation, she said.
Consumer strength not seen earlier this summer, as evidenced by an increase in auto sales, consumer credit, and back-to-school retail, is adding to the inflationary climate. Commodities prices are also up.
Although the Federal Reserve has raised interest rates five times already this year, with the most recent federal funds rate tightening of 50 basis points coming on Aug. 16, the market is watching for another Fed move.
"At this point, I don't think [the PPI report] changes the widespread expectation for a November tightening," Bikhazi said. "But the market won't wait for a Fed move -- it'll start tightening by itself. We need two or three more bad numbers like this to convince the Fed to tighten earlier."
Since the last Fed tightening, the market has seen a steady steepening of rates in the short end along with a flattening of the yield curve from two years on out. Overall, rates are elevated, with yields in the short end well into the 6% to 7% range compared to January's levels of 4% to 5%.
Munro said the short end showed a "sharp reaction" to the PPI, while the long end continues to look for assurances that growth will be held to 2.5%. It is now more at 3% to 3.5%, he said.
"The long end of the curve has already priced in some wariness of inflation," Munro said.
The Fed has moved 175 basis points this year, and some analysts believe it has done all the restraining it can for the time being. So there is no expectation in some quarters that the short end will go up further, Munro said.
On other hand, he said, Friday's numbers showed that the Fed may have to move more because the process of slowing down the economy is not over yet. "It's clear the indicators are not rolling over and dying," Munro said.
While the short end is behaving as the Fed wants it to, Munro said, the long end has gone up more than the Fed would have expected. As a result, he said, the Fed may not be on hold very long.
By the close of trading Friday, the dollar was quoted at 1.5370 German marks and 99.15 Japanese yen.
The 10-year Treasury note was down more than one point to yield 7.42%. The seven-year note was down more than 7/8 to yield 7.23% and the five-year was down more than 5/8 to yield 7.04%.
The yield on the three-month bill was up three basis points to 4.66%. The yield on the six-month bill was up eight basis points to 5.12%, and the yield on the one-year was up 11 points to 5.64%.
The December Treasury bond futures contract closed down almost 1 5/8 to 87 29/32.
The largest Mexican private deal done so far this year came to the corporate bond market last week, Bankers Trust said.
CEMEX S.A. de C.V. announced the pricing of its $300 million offering of seven-year global registered notes, at par to yield 9.50%, with a semiannual coupon of 9.5%.
The yield spread to Treasuries is the tightest achieved by a Mexican private sector company, according to a release from Bankers Trust, the lead manager for the deal. The spread was 240 basis points.
BT Securities Corp. acted as lead placement agent for the 144A tranche.
The noncallable notes, due Sept. 20, 2001, are rated Ba2 by Moody's Investors Service and BB-plus by Standard & Poor's Corp.
CEMEX will use net proceeds of the sale to repay some of its shortterm debt. The company is the largest cement producer in the Americas and ranks among the largest publicly traded industrial companies in Mexico.
In the secondary market, spreads on investment-grade debt tightened as prices of corporate bonds plummeted, but not to the extent of Treasuries. Prices on long-term corporate bonds were down 7/8 to 11/4.
Below-investment grade bonds also ended down, with prices dropping 1/2 to one point. Aaron Pressman contributed to this column.