Smiles were in short supply in the bond market yesterday as weak demand for the Treasury's 10-year note auction sent prices sharply lower.
News that the second leg of the Treasury's quarterly refunding went particularly badly sent the 30-year bond down more than 1 1/8 points, to yield 7.60%.
The Treasury auctioned $12 billion of 10-year notes at an average yield of 7.36%, with a tail of four basis points. Traders were expecting the auction to be sold at much lower levels, with most calling for an average yield of 7.33%.
Also reflecting a poor auction, the bid-to-cover ratio was 1.88 to one, significantly below the last 10-year auction's ratio in February of 2.58 to one.
"The 10-year auction was miserable, and the market didn't like it," said Brian Wesbury, chief economist at Griffin Kubik, Stephens & Thompson Inc.
Wesbury said the auction succumbed to a negative environment created by the Federal Reserve's failure to execute its anticipated rate hike prior to the refunding. In addition, players remain reluctant to own too much paper going into this week's key economic reports, he said.
The producer and consumer price indexes are due today and tomorrow. April retail sales are due today.
Tuesday's rally in the Treasury market probably explains in part why demand at yesterday's 10-year auction was weaker than expected, as many traders had already covered their short position, dealers said.
Solid demand Tuesday for the first of this week's quarterly refunding package sent buyers funneling into a market that had sold off sharply in recent sessions on fears that buyers would not bid on the note sales.
The Fed failed to raise short-term interest rates yesterday, and the market believes the next tightening will probably come after the May 17 meeting of the Federal Open Market Committee, said Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp.
Schaja, like most market observers, expects the central bank to raise the federal funds rate 50 basis points to 4.25%, along with a 50-basis-point increase in the discount rate to 3.50%.
In the meantime, bond investors will cope with distributing new supply and two potentially negative inflation report this week. "The inflation number will help set the tone for the market and provide the Fed with its first comprehensive look at price pressures in the economy in April," a market strategist said.
Early trading activity was dominated by news of the Bundesbank's 50-basis-point cuts in both the discount and Lombard rates. The rate cuts were more aggressive than expected. Most analysts were looking for a 25-basis-point cut in both rates.
The German rate cuts fueled speculation than the Federal Reserve may not have to be as aggressive in its next rate increase because of reduced pressure on the dollar. The weak dollar has been a persistent problem for fixed-income investors, who worry about the effects of currency volatility on their portfolios.
Investors in dollar-denominated instruments believe that higher U.S. interest rates relative to other industrialized countries will attract capital flows to the Treasury market as yield-hungry investors look for higher rates of return.
In futures, the June bond contract ended down more than a point at 102.02.
In the cash markets, the 5 1/2% two-year note was quoted late Wednesday down 4/32 at 98.23-98.24 to yield 6.18%. The 6 1/2% five-year note ended down 15/32 at 97.24-97.26 to yield 7.02%. The 5 7/8% 10-year note was down 27/32 at 89.05-89.09 to yield 7.43%, and the 6 1/4% 30-year bond was down more than 1 1/8 points at 84.01-84.05 to yield 7.60%
The three-month Treasury bill was down three basis points at 4.30%. The six-month bill was up one basis point at 4.94%, and the year bill was up four basis points at 5.48%.
Merrill Lynch & Co. offered $250 million of floating-rate Euronotes due May 25, 1999, at an issue and fixed re-offer price of 99.90 via lead underwriter Merrill Lynch International Ltd.
The bonds pay interest quarterly at the three-month London interbank offered rate plus 1/4 point. The borrower's outstanding senior debt is rated A1 by Moody's Investors Service Inc. and A-plus by Standard & Poor's Corp.
Commissions were not disclosed. The London-listed bonds are issued in denominations of $1,000,$10,000, and $100,000.
In rating news, Fitch Investors Service affirmed General Motors Corp.'s A-minus senior debt and BBB-plus preference shares and said the credit trend is improving.
GM and the Pension Benefits Guaranty Commission have reached an agreement under which GM could contribute about $10 billion to its U.S. hourly pension plans by September 1995. Specifically, GM will contribute 177 million shares of GM class E common stock, with a current market value of about 6.3 billion, plus $4 billion in cash to the plan, said Fitch. The contribution, which is subject to obtaining Department of Labor exemptions, is incremental to the ongoing contributions GM is making to the fund, the rating agency said.
Fitch said it views this action as positive for GM, in that it represents a substantial attack on the liability and underscores the company's commitment to fund the shortfall quickly.
At yearend 1993, GM's net global unfunded pension liability totaled $22.3 billion, of which $18.5 billion was in the U.S plans. The global unfunded liability rose from $14 billion at yearend 1992, as GM lowered the discount rate for the U.S plans to 7.1% from 8.6%, and lowered the non-U.S. rate as well.
Fitch said during the first quarter of 1994, GM contributed $1.9 billion to the U.S. plans, satisfying the 1994 ERISA minimum. In preparation for the actual and anticipated contributions, the unfunded liability drops to $10.2 billion, and could fall further if current interest rates prevail and the discount rate is raised. Each 100-basis-point move in the discount rate changes the liability by about $5 billion.