Strong news on the economy caught the market off guard yesterday, sending yields sharply higher and casting an element of uncertainty into the outlook for Treasuries.
The 30-year bond closed almost 1 1/2 points lower yesterday, to yield 5.95%.
A number of strong economic reports spooked the market because they suggested that the benefits of low interest rates may finally be working their way into the economy. For the first time in several weeks, traders reported widespread retail selling of Treasuries.
The sell-off left the market in a tenuous position going into today's producer price index. If the report is unfriendly to the market, the combination of technical indicators turning bearish and fears of higher inflation could be enough to trigger a major correction.
Should the release show that inflation remains under wraps, market participants expect buyers to emerge to take advantage of the yield levels brought on by yesterday's declines.
"We'll have to see what other reports show before we conclude whether the bullish trend is still on or if it's over," said Fred Leiner, market strategist at Continental Bank.
He said today's PPI report and Monday's consumer price index will play major roles in the debate between bulls and bears, as much of the market's recent rally was based on the outlook for low inflation. Expectations for PPI center on an increase of 2.0%.
The sell-off began in overseas trading as foreign investors reacted to wire service reports that a U.S. House panel is discussing a possible withholding tax on interest to foreign investors. The reports, which most market observers said were misinterpreted, gave way to selling in Tokyo and London.
Daniel Seto, economist at Nikko Securities, said the market shrugged off the reports when it realized that the House Ways and Means Committee was merely scheduling a Sept. 21 hearing on the bill.
A number of strong reports on the economy prompted a wave of further selling at the start of New York trading. Treasury prices across the curve lost much of the momentum of the market's recent rally.
The ABC/Money Magazine consumer comfort index rose to negative 36, a 13-week high. The strong reading on the closely watched weekly survey took market participants by surprise and prompted selling across the yield curve.
In other strong data, the Mortgage Bankers Association's index on mortgage loan activity surged to 1616.6 from 1433.2. The purchases index was up to 189.5 from 176.2, while the effective rate on a conventional 30-year mortgage was 7.00%, down 10 basis points from the previous week.
The Labor Department reported that jobless claims fell 10,000 to 316,000. Claims had been expected to rise by 1,000. The number of initial claims was the lowest since June 3, 1989.
Market participants said these factors conspired to bring the market's recent rally to a sudden halt, but that it is too soon to tell whether the strong economic data will hamper the market's ability to maintain recent gains.
The jobless claims figures were particularly worrisome to the market. But while observers were encouraged by recent activity in jobless claims data, they noted that the overall labor market remains weak. "You have a decrease in the amount of people being laid off, but the economy is not creating jobs to make up for those lost jobs," Seto said. "One offsets the other."
Many investors used price declines on the data as an excuse to take profits, while others lined up to buy at lower levels. That two-way flow allowed the market to stabilize at lower levels and provided participants with a chance to take a breather.
Prices came under selling pressure late in the session as retail accounts looking to take profits on upticks lost patience and began lightening their inventories of bonds.
Comments by central bank officials were generally constructive for the market. Federal Reserve Board Governor John LaWare said demand for credit remains weak, while San Francisco Fed President Robert Parry said he sees moderate growth through 1994 and further improvement in inflation.
Market players agreed with those assessments, and said that fundamentally nothing has changed to make Treasuries unattractive; rather, some investors are looking to book profits after the market's recent rally.
Proof of the positive tone of the market came from mortgages, as money continued to flow into Treasuries. And as long as the flood of cash into Treasuries from mortgage-backed securities and municipal defeasance continues, market participants still see the downside as limited.
Observers of the mortgage-backed market were encouraged by the hefty increase in the Mortgage Bankers' refinancing index because there will be more loans to bundle together and sell as bonds.
The flip-side of this scenario would be a backup in long-term interest rates, they said. If rates continued to climb, dealers said that prepayments will slow considerably and deprive the Treasury market of an important source of sponsorship.
Late yesterday, the New York Fed released its weekly money supply figures. In the week ended Aug. 30, M1 rose $1.7 billion, M2 fell $5.3 billion, and M3 fell $1.9 billion.
In futures, the September contract ended down 113/32 to 120.14.
In the cash markets, the 3 7/8% two-year note was quoted late yesterday down 7/32 at 99.31 - 100.00 to yield 3.87%. The 4 3/4% five-year note ended down 17/32 at 100.00-100.02 to yield 4.73%. The 5 3/4% 10-year note was down 31/32 at 103.01 - 103.03 to yield 5.34%. And the 6 1/4% 30-year bond was down 44/32 at 104.01 - 104.03 to yield 5.95%.
The three-month Treasury bill was up three basis points at 2.99%; the six-month bill was up three basis points at 3.09%; and the year bill was up six basis points at 3.24%. Treasury Market Yields Prev. Prev. Thursday Week Month 3-Month Bill 3.03 3.03 3.066-Month Bill 3.16 3.16 3.191-Year Bill 3.34 3.31 3,382-Year Note 3.87 3.80 3.963-Year Note 4.15 4.13 4.355-Year Note 4.73 4,75 5.047-Year Note 4.94 5 00 5.3410-Year Note 5.34 5.40 5.7030-Year Bond 5.95 6.03 6,34 Source: Cantor, Fitzgerald/Telerate