Short-term Treasury prices fell out of bed yesterday as the market gave up hopes of getting an immediate easing in Federal Reserve monetary policy.
The Treasury's auction of $10.26 billion of five-year notes added to the pressure on the short end of the market.
By late in the day, short-and intermediate-term notes were off 1/4 to 3/4 points, and the 30-year bond was off 5/8 point to yield 7.86%. Short-term prices suffered most because they are most closely linked to Fed policy.
The market began pricing in another cut in the Fed's funds rate target a couple of weeks ago, after the M2 money supply posted a $9.7 billion plunge, and the rate-cut fever peaked Tuesday when a 17% plunge in April housing starts seemed to give Fed policymakers another reason to vote for an easing at that day's meeting.
Traders expecting a Fed ease began to get nervous Wednesday when the Fed failed to signal a change in policy.
Yesterday morning The Wall Street Journal squashed the easing hopes completely when it reported that "people familiar with the Fed's deliberations" said the Federal Open Market Committee voted against easing monetary policy at Tuesday's meeting.
Moreover, the Journal story said the committee approved a policy directive that was symmetrical, rather than biased toward easing, for the first time since last July.
Economists said the Journal's track record in reporting on Fed policy decisions suggested the article was accurate.
They said, though, that even if the Fed voted to erase its bias toward easing this week, it could still cut its funds target in the future if the indicators provide more evidence of economic weakness.
Analysts said they believe Mr. Greenspan would retain the authority to trim the federal funds rate 25 basis points, to 3.5%, even if the FOMC adopted a symmetrical policy directive.
"The chairman always has the option under a directive, even if it's symmetrical, to go one way or the other, depending on which way the data go, but the case has to be more compelling," said Lyle Gramley, chief economist for the Mortgage Bankers Association and a former member of the Fed's board of governors.
David Berson, chief economist for the Federal National Mortgage Association, agreed. "It makes it less likely it's going to happen in the next week or two, but it certainly doesn't preclude the Fed's easing if economic conditions warrant."
Either a weak purchasing managers' report or a weak employment report next month could trigger a cut in short-term rates if the money supply continues to be sluggish, said Mr. Berson.
Treasury Secretary Nicholas Brady told reporters the administration continues to favor lower U.S. rates and more rapid growth in the money supply, which is at the bottom of the Fed's target range. Mr. Brady said he does not want to see a repeat of last year's events, when money supply slowed and the recovery faltered.
Treasury prices responded quickly and violently to the Journal's report.
The market began to decline in Tokyo as Japanese traders heard of the article, stabilized during the London morning session, then moved lower early in the New York session.
The market came under more pressure in the mid-afternoon yesterday even though the five-year auction results looked reasonably good.
"The auction in and of itself was okay," said Jerry Zukowski, an economist at PaineWebber Inc. "The market's still smarting from the [Fed] news and the fact that they were positioned very, very long and for the moment, very, very wrong."
In fact, traders said the higher yield on the when-issued five-year note drew in some bidders at the auction.
The notes, which were yielding 6.59% late Wednesday, had traded back to 6.74% at auction time.
The $10.25 billion of five-year notes came at an average yield of 6.75% and will bear a 6 3/4% coupon. That compares with the 6 7/8% coupon and 6.93% average yield at last month's five-year sale.
The results were a little better than expected at bidding time, when traders thought some bids would be awarded at 6.76%. Instead the auction stopped at 6.75%, with bidders at that level getting 94% of what they asked for.
After bids were submitted, buying in the secondary market pushed the yield of the when-issued five-years as low as 6.71%. But later in the afternoon, the new five-years drifted lower, and at one point the yield on the notes got as high as 6.79%, before bouncing back to 6.75%.
Traders blamed the deterioration during the afternoon on a lack of follow-through buying for the five-year issue, combined with dealers efforts to get rid of securities ahead of the Memorial Day weekend.
The public Securities Association has recommended an early close today, at 1 p.m., e.d.t., and the bond market will be closed Monday for Memorial Day.
"Going into the long weekend, people just lighten up on their positions," a note trader said.
The market ignored yesterday's economic news as it thrashed out the implications of a steady Fed policy.
Analysts said the bigger-than-expected decline in jobless claims provided backing for the Fed's decision to forego another easing. The Labor Department reported that new filings for unemployment insurance fell 20,000 to 406,000 in the week ended May 9. Economists had forecast only a 6,000 decline.
Also yesterday, the Treasury said the government had posted a $14.6 billion surplus in April, down from the $30.1 billion excess a year earlier.
Late in the afternoon, a spokesman for the Federal Reserve Bank of New York reported at the bank's weekly press briefing that all three measures of nation's money stock has risen in the week ended May 11, with the M1 money supply up $3.8 billion to $945.8 billion in the week ended May 11; the broader M2 aggregate up $5.4 billion to $3.5 trillion; and M3 up $6.9 billion to $4.2 trillion.
A note trader said the Treasury market's ability to hold its ground in the face of those money supply numbers suggested the worst of the downtrade might be over.
The June bond futures contract closed 19/32 lower at 100 17/32.
In the cash market, the 30-year 8% bond was 5/8 lower, at 101 14/32-101 18/32, to yield 7.86%.
The 7 1/2% 10-year note fell 27/32, to 100 24/32-100 28/32, to yield 7.37%.
The three-year 5 7/8% note was down 7/16, at 100 1/32-100 3/32, to yield 6.84%.
In when-issued trading, the 5 1/8% two-year notes were 7/32 lower at 99 20/32-99 21/32 to yield 5.30%. That compares to the 5.13% average at Wednesday's auction.
Rates on Treasury bills were higher, with the three-month bill up 10 basis points at 3.69%, the six-month bill off 10 basis points at 3.80%, and the year bill 15 basis points higher at 4.05%.
In other news, the New York Fed reported that the federal funds rate averaged 3.89% for the week ending Wednesday, up from 3.84% the previous week.