Strong economic news and tepid demand for new supply sent Treasury market prices into a freefall yesterday as investors unloaded bonds.
The 30-year bond closed down a1-more than 1 3/4 of a point, to yield 7.26%.
The market began to descend in early trading after it failed to respond positively to what initially appeared to be weaker-than-expected economic news. The downward price action served as a reminder that the bearish trend remains intact and that the market has seen its near-term highs, players said.
The Commerce Department reported that gross domestic product expanded at a 2.6% rate in the first quarter, below market expectations.
While the GDP report confirmed that the economy cooled during the first three months of the year it failed to dampen bond market expectations that Federal Reserve officials will raise short-term interest rates again in May. Bond prices surged when it appeared that GDP was weaker than expected. Players soon realized, however, that it was the headlines that seemed weaker, not the actual details of the report, and they began selling government securities. Most investors believe the current growth trend is much stronger than the first-quarter headline figure suggested.
The bloodbath continued after the Treasury Department reported weak demand for its monthly five-year note sale. The Treasury awarded $11 billion five-year notes at an average yield of 6.60%, well above expectations. The bid/cover ratio was 2.13-to-1 and non-competitive bids totaled $712 million.
"The market got hit with disappointing news on the economy and a bad notes auction which pushed prices lower across the board," said Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp. "It's clear the market got a bit ahead of itself in trading higher the last few days and people sold many of the securities they purchased."
Analysts generally agreed that the market overreacted by aggressively selling Treasuries in response to developments yesterday. But even after yesterday's sharp sell-off, Treasury yields remain in the middle of recent ranges and are not poised to test recent highs.
Schaja said a sharp increase in commodities prices and the weak dollar contributed to the bond market's declines yesterday. The Commodity Research Bureau's index of commodities futures rose 1.62 points to 223.27, while the U.S. dollar continued to decline against the yen amid growing fears of a trade war between the United States and Japan. The dollar closed at 101.40 yen.
Other market players said the 31,000 decline in weekly jobless claims might foretoken a strong April employment report. Weekly claims figures continue to point toward improved U.S. labor conditions, they said.
Weakness in the cash and futures market led to a distinct deterioration in the technical state of the government securities market. The June bond futures contract crashed through technical support at 105 28/32.
"Treasuries really took a turn for the worse when the futures market caved in," a bond trader said. "The fact that long-standing support levels were taken out hurt market sentiment and spurred some of the larger hedge funds to sell bonds."
Dealers reported heavy retail selling yesterday as pension funds and institutional investors scrambled to sell Treasuries and avoid further losses on their fixed-income investments.
The Treasury's auction of five-year notes drew poor demand, reflecting negative sentiment in the credit markets that may carry over into next months' quarterly refunding, analysts said.
The prospect of taking on new supply this week put dealers on the defensive and kept retail investors on the sidelines. Amid signs that the U.S. economy continues to gain steam and fears that the Federal Reserve will again boost short-term interest rates, few investors were willing to place bets.
Another negative development for the bond market yesterday was the loss of investor optimism that the economy is not growing. The Treasury market's strong performance in recent sessions reflected a growing belief that the economy was no longer expending.
In futures, the June bond contract ended down almost two points at 104.24.
In the cash markets, the 5 1/2% two-year note was quoted late Thursday down 7/32 at 99.18-19 to yield 5.71%. The 5 7/8% five-year note ended down 3/4 point at 96.28-96.30 to yield 6.61%. The 5 7/8% 10-year note was down more than a point at 92.00-92.04 to yield 6.99%, and the 6 1/4% 30-year bond ended down more than 1 3/4 at 87.19-87.23 to yield 7.26%.
The three-month Treasury bill was down one basis point at 3.95%. The six-month bill was up two basis points at 4.41%, and the year bill was up 10 basis points at 4.95%.
Citing market requests for ratings that apply specifically to the credit risks of derivatives claims, John Bohn, president of Moody's Investors Service Inc., said the rating agency is expanding its counterparty ratings as part of a deeper research commitment to derivatives risk.
Moody's has tracked derivatives activity, such as swaps and options, for some time, Bohn said. As risks that may affect the creditworthiness of participants have mounted, Moody's has concluded that it must enlarge this ratings service, he said. The commitment to deeper company-wide research into derivatives risk is aimed at eliminating potential market confusion and misunderstanding.
The need for ongoing recognition of derivative activities in the credit evaluation process, Bohn said, stems from the continued rapid global growth of derivatives activity. Market participants worldwide are demanding specific, incisive research and ratings on derivatives-related risks, he said.
Bohn said Moody's will be materially enhancing its analysis focus on how issuers' derivatives activities can affect their credit fundamentals, and also on derivatives risks and counterparty creditworthiness in the derivatives market. Moody's has assigned counterparty ratings to 276 U.S. banks and thrifts that are major players in the derivatives market. These institutions collectively account for virtually all of the derivatives activities of U.S. banks and thrifts, Moody's said.
Moody's counterparty ratings use the rating agency's "Aaa-through-C" rating symbols. The ratings will be continuously monitored, and will be publicly available to all market participants globally, the rating agency said. In other ratings news, Standard & Poor's Corp. said it raised its rating on Bell Atlantic Financial Services Inc.'s senior unsecured debt to A-Plus from A and affirmed the A-1 rating on the company's commercial paper.
The ratings of these three Bell Atlantic Corp. units were removed from CreditWatch surveillance list where they were placed Feb. 25, following Bell Atlantic Corp.'s announcement to terminate plans to acquire Tele-Communications Inc. (TCI).
Bell Atlantic Corp.'s implied senior debt rating is A-Plus, the rating agency said. About $10 billion of Bell Atlantic's consolidated debt is outstanding, according to Standard & Poor's.
In other news, Eastern Airlines said it is discussing a reorganization plan with major creditors that would give birth to a new airline. Eastern is currently in Chapter II bankruptcy.
In a press release from trustee Martin R. Shugrue Jr., the company said the plan would be an alternative to simply liquidating assets and paying a dividend to creditors over the next few years. The company said the court-appointed trustee and his advisers and legal counsel have been investigating the possibility of employing Eastern's remaining assets in a new airline operation and have been developing a business plan to accomplish the goal. The trustee said that using Eastern's assets in an operating airline would enable credits to receive a greater payment on their claims than through liquidation.
The trustee said the viability of the plan will depend on many factors including outside capital investment. To assist the trustee in raising the necessary capital, Coopers & Lybrand has been retained as financial advisor with the approval of the bankruptcy court.