U.S. government securities barely budged yesterday as participants geared up for an expected tightening of credit after today's meeting of U.S. monetary policymakers.
Prices generally ended marginally lower, led by the 30-year bond, which closed down 3/32 to yield 7.50%. At the short end, the two-year note ended down 1/32 to yield 6.24%.
Market observers generally expect the Fed to raise short-term interest rates after today's meeting of the Federal Open Market Committee. The only debate among bond market analysts is how much Fed members will raise rates, not whether they will.
"Everyone's waiting for the Fed, and things are on hold until then," said Fred Leiner, bond market strategist at Continental Bank.
Amid signs that the U.S. economy continues to navigate a steady path toward full capacity and evidence that price pressures are stirring, fixed-income investors are depending on the central bank to tighten credit conditions and renew its vow to keep inflation under wraps.
Although monetary policy analysts have been pleased with the sedate inflation results, the price gauges are lagging indicators, and the Fed will continue tightening preemptively as long as economic growth continues above 3%, said Joshua N. Feinman, analyst at Bankers Trust Co.
On the bright side, Feinman said, the core consumer price index was up only 0.2% in July, and the core producer price index rose just 0.1%. Moreover, Fed chairman Alan Greenspan recently told Congress that the consumer price index might even be overstating inflation.
Still, Feinman believes the Fed will tighten, asserting that a 3% or higher rate of growth would push the economy closer to its capacity constraints and thus threaten to accelerate inflation down the road.
Most market participants generally expect the central bank to raise the federal funds rate target by 50 basis points to 4.75%, which they say would help calm nerves in the bond market even more. However, a number of market participants are calling for a 25-basis point move.
In recent sessions, players have come to grips with talk that the Fed may only move by 25 basis points. Many observers believe a quarterpoint rise in the funds rate would increase uncertainty because it would leave the prospect of additional tightening hanging over the market.
Analysts believe a strong dose of tightening would lift the long end of the Treasury market out of its recent slump. An aggressive move by the Fed would relieve much of the overhang from last week's refunding auctions, they said, noting that much of the $40 billion of new government debt sold then has yet to be distributed in the marketplace.
"At this point in the business cycle, it's better for the Fed to err on the side of a restrictive policy than err on the side of easier policy," Leiner said.
Steven Ricchiuto, chief economist at Barclays de Zoete Wedd Securities, agreed, saying that the Fed's decision will be biased toward further tightening of reserve market conditions. "Given that the recent round of economic figures was mixed, reinforcing the committee's inflation-fighting credibility will be a primary intent in this policy decision," Ricchiuto said.
If there is no rate increase this week, the long end could sell off as investors move money in on the yield curve to avoid volatility caused by fears of future inflation, observers said.
Not all Wall Street analysts subscribe to the 50-basis point scenario. A growing number believe an aggressive tightening would unnecessarily raise warning flags in the market that inflation is rising faster than conventional measures currently suggest.
The analysts argue that the more gradual increase of a quarter point in the funds rate target would allow the Fed to send a message of restraint to the bond market, while at the same time giving it room to analyze upcoming reports on the economy and decide on the proper level for short-term rates.
Dana Johnson, head of market analysis at First Chicago Capital Markets Inc., said the decision the Fed makes this week will reveal a great deal about the Fed's intentions. "The issue at stake is whether the Fed is willing to risk being overly restrictive as it tries to slow economic growth to a more sustainable pace," Johnson said.
In the futures market, the September bond contract ended down 6/32 at 102.19.
In the cash markets, the 6 1/8% two-year note was quoted late yesterday down 1/32 at 99.24-99.25 to yield 6.24%. The 6 7/8% five-year note ended down 2/32 at 99.19-99,21 to yield 6.95%. The 7 1/4% 10-year note ended down 4/32 at 99.18-99.22 to yield 7.29%. The 7 1/2% 30-year bond ended down 3/32 at 99.26-99.30 to yield 7.50%.
The three-month Treasury bill ended up eight basis points at 4.54%. The six-month bill closed up four basis points at 5.13%. The year bill ended up one basis point at 5.58%.
Aegon NV issued $400 million of 12-year notes to yield 8.12%, or 83 basis points more than the U.S. 10-year Treasury, according to lead manager J.P. Morgan Securities Inc.
The noncallable notes were priced at 99.087 and bear an 8% coupon. They were rated A1 by Moody's Investors Service and AA-minus by Standard & Poor's Corp.
Otherwise, the primary market for corporate securities ground to a halt yesterday as issuers and investors wondered whether the Fed would raise short-term rates this week.
With intermediate and long-dated Treasuries feeling the weight of new supply from the August refunding, corporate debt issuers kept their offerings on the shelves. Also, few investors were willing to risk taking positions ahead of a possible monetary tightening this week.
In the secondary market for corporate securities, spreads of investment-grade issues tightened by about 1/4 of a point, while high-yield bonds generally ended unchanged. Treasury Market Yields Previous Previous Monday Week Week 3-Month Bill 4.54 4.57 4.336-month Bill 5.13 5.09 4.801-year Bill 5.58 5.57 5.292-Year Note 6.24 6.20 5.963-Year Note 6.58 6.49 6.285-Year Note 6.95 6.93 6.777-Year Note 7.12 7.07 6.9610-Year Note 7.29 7.27 7.1830-Year Bond 7.50 7.53 7.50
Source: Cantor, Fitzgerald/Telerate