Treasury prices took a beating yesterday morning when a huge increase in October producer prices cast doubt on the bond market's optimistic inflation outlook.
But good retail buying at lower prices, combined with some doubts about the producer price statistics, helped the market recover a large part of its earlier losses.
By late in the afternoon, the 30-year bond was almost a point lower and yielded 7.86%; the long bond had been off as much as 1 5/8 points in the initial downtrade.
Economists forecast a 0.1% gain in October producer prices, so the 0.7% jump in the producer price index and the 0.5% increase in the core rate, excluding food and energy costs, came as an ugly shock to the market.
Prices plunged after the numbers flashed on the screens as retail accounts rushed to dump paper on dealers. The dealers, who already had long positions, responded by selling futures, and that pushed the contract through key technical support levels.
"Judging by the violence of the reaction, a lot of people were long," a government note trader said.
But at those lower price levels, some retail accounts and dealers decided that Treasury securities looked like a bargain against the backdrop of a faltering economy. Their purchases brought prices off the lows.
The market also got a hand at midday from some friendly news items.
First, wire services reported that an unnamed senior Federal Reserve Board official had suggested the jump in producer prices was an aberration.
And one service reportedly said the official had refuted a report in Tuesday's Los Angeles Times that the Fed was finished easing for the year.
A little later there were rumors that the Bureau of Labor Statistics was considering revising the producer price report.
The speculation apparently grew out of the government's admission that seasonal adjustments caused one portion of the report, consumer durables, to be overstated. But a spokesman for the bureau said any change would have to wait until February, when annual revisions to the seasonal factors are made.
Early-November car sales came in a little weaker than expected yesterday, even though expectations were low to begin with, but traders were too busy to pay much attention.
For the first 10 days, cars sold at a 5.7 million unit annual pace. That is below the 6 million forecast and down from the 6 million sold in October and the 6.3 millio September sales rate.
PPI: Just One Bad Month?
Analysts cautioned against making sweeping judgments about inflation trends from one month's worth of producer price statistics but said the 0.5% gain in the core rate of October producer prices was too broadly based to be ignored.
In addition to the 1.7% rise in energy costs and 0.4% increase in food prices that contributed to the 0.7% increase in the overall index, the core rate showed higher prices for a variety of products, including tobacco, tires, autos, pharmaceuticals, and soap.
"There was a broad list of diverse products whose prices surged in a big way," said Brian Fabbri, chief economist at Midland Montagu. "It's certainly troublesome to the bond market."
Cynthia Latta, a financial economist at DRI/McGraw Hill, argued that the market had erred in thinking that the sluggish economy would prevent businesses from passing along higher costs to their customers.
"This is a reminder that at some point, those cost increases have to be passed along," Ms. Latta said. "They cannot all be offset by productivity increases."
But she added that the fact that so many different price increases hit in the same month probably was a "statistical fluke," and she does not expect to see similar gains in coming months.
Frederick Sturm, a senior economist at Fuji Securities, said he considered the October producer price report an exception to the rule.
Treasury Market Yields
Wednesday Week Month
3-Month Bill 4.76 4.77 5.09
6-Month Bill 4.86 4.90 5.21
1-Year Bill 4.97 4.94 5.26
2-Year Note 5.62 5.62 5.84
3-Year Note 5.97 5.95 6.11
4-Year Note 6.07 6.04 6.27
5-Year Note 6.66 6.70 6.79
7-Year Note 7.06 7.14 7.14
10-Year Note 7.40 7.50 7.44
15-Year Bond 7.69 7.81 7.72
30-Year Bond 7.86 7.99 7.88
Source: Cantor, Fitzgerald/Telerate
"If you look at the components that contributed to this big increase, the big culprits, particularly tobacco and tires, represent economic sectors in which the fundamentals are quite weak, sectors in which there's very little reason to think price pressures will persist," Mr. Sturm said.
"This is just a wiggle in an otherwise prevalent trend to lower inflation," he said.
Ian Borsook, a senior economist at Merrill Lynch & Co., said the general weakness in the economy argued against a repetition of yesterday's producer price report, as did the good behavior of prices at the intermediate and crude levels.
On the other hand, he said, there are reasons to expect food and energy prices to continue to increase in coming months, which will put upward pressure on the overall index.
Traders said the market will approach today's indicators with caution after yesterday's fender-bender trading.
Economists surveyed by The Bond Buyer expect October consumer prices to rise 0.2%, with a 0.3% increase in the core rate. But after the huge rise in producer prices, they said the risk was the increases would be bigger.
The economists expect October retail sales to fall 0.2%.
The December bond future contract closed 29/32 lower, at 100 3/32.
In when-issued trading, the 30-year 8% bond was 29/32 lower, at 101 14/32-101 18/32, to yield 7.86%.
The when-issued 7 1/2% 10-year note fell 13/32, to 100 18/32-100 22/32, to yield 7.40%.
The when-issued three-year 6% note was off 1/16, at 100-100 2/32, to yield 5.97%.
Rates on Treasury bills were mixed, with the three-month bill up two basis points at 4.65%, the six-month bill down one basis point at 4.69%, and the year bill two basis points higher at 4.75%.