The Treasury market headed for higher ground yesterday as two reports supported the notion that the U.S. economy isn't overheating.
Prices surged immediately following the release of favorable May consumer price index and retail sales reports, both of which provided evidence that price pressures in the national economy remain under wraps.
The 30-year bond ended up 1/2 a point, to yield 7.30%.
The May CPI rose a less-than-expected 0.2%, with the core climbing 0.3%. May retail sales were expected to have been unchanged, but instead fell 0.2%.
"[Federal Reserve Chairman Alan] Greenspan can put away his pipe wrench," said Jay Goldinger, chief investment strategist at Capital Insight in Los Angeles. "The CPI results show that inflation has been trapped in a box. This should be an all-clear signal for no more tightening."
The CPI report, coupled with last Friday's producer price report, offered bond investors their first comprehensive view of national price pressures in May and provided the Fed with a blueprint for the direction of short-term interest rates, market participants said.
And bond investors who were wondering whether spending on the national level will remain an engine of economic growth or sputter out as the economy growth or sputter out as the second quarter got their answer from Tuesday's weak retail sales figures.
Accounts on the buy-side of the market were active in the Treasury market yesterday, particularly at the short end of the yield curve. Traders said the soft economic reports left retail players more confident about owning government-backed paper. Part of that confidence grew out of the notion that signs of softer growth in the national economy will enable the central bank to hold steady on interest rate policy, traders said.
John Silvia, chief economist at Kemper Mutual Funds, believes a favorable reading on the industrial production and capacity utilization will take some pressure off the Federal Reserve to raise interest rates.
But even with the likely drop in May, capacity utilization will remain high, Silvia said, identifying several sectors with rates greater than 90%, including lumber, motor vehicles, textiles, paper products, and petroleum. "While inflation pressure remain in the background now, these are areas worth watching for future inflation trends," he said.
The inflation-sensitive bond market will keep an eye on the Federal Reserve's reports on production and capacity today. With capacity at the nation's factories hovering dangerously close to 84%, investors wonder how far behind wage pressures could possibly be.
Southeastern manufacturing activity accelerated to 39% in May from 31% in April, but remained at a more moderate pace than in the first quarter, the Federal Reserve Bank of Atlanta said yesterday in its regional monthly survey.
The share of respondents reporting higher prices for finished products held steady, although reports of higher materials prices increased noticeably. Manufacturers anticipate growth of future production activity to moderate in the coming months.
Companies reporting increased employment rose slightly, but a smaller percentage reported a longer workweek. In addition, most continued to expect no change in the number of employees and the workweek.
For current activity, the proportion of survey respondents reporting increases in production rose to about 39% in May from 31% in April. The diffusion index for production stood at 21.4 in May compared with a revised 13.0 in April.
Part of May's rebound appears to have been due to recovery from the effects of the teamsters' freight strike in April. Shipments and new orders followed a similar pattern, although backlogs appear to have eased.
Producers are seeing higher prices for materials to produce products but report that finished goods prices have largely remained stable, the Atlanta Fed said. The share of respondents reporting higher materials prices rose to 38% in May; the prices paid diffusion index was 33 in May compared with 23 the month before.
The prices paid index has been on an upturn since December, the survey said. For finished product prices, the share reporting price increases stood at 17% in May, little changed from 18% in April. For the outlook respondents expect continued moderation from sustained growth last year as well as from a robust first quarter in the Southeast.
Although the share expecting increases in production in six months rose to 45% in May from 41% in April, the share expecting a decline increased to 25% in May from 15% in April. The share reporting increased capital spending plans was little changed at 33% in May compared with 32% in April.
In futures, the September bond contract ended up 23/32 at 105.21.
In the cash markets, the 5 7/8% two-year note was quoted late Tuesday up 3/32 at 100.04-100.05 to yield 5.78%. The 6 3/4% five-year note ended up 10/32 at 100.22-100.24 to yield 6.56%. The 7 1/4% 10-year note was up 14/32 at 101.22-101.26 to yield 6.99%, and the 6 1/4% 30-year bond was up 1/2 a point at 87.07-87.11 to yield 7.30%.
The three-month Treasury bill was unchanged at 4.26%. The six-month bill was up three basis points at 4.8%, and the year bill was up four basis points at 5.34%.
Corporate Securities
In the largest deal so far this week, the Tennessee Valley Authority issued $850 million of bonds due June 15, 2044, said sole manager Morgan Stanley & Co.
The bonds were given a coupon of 7.8% and priced at 99.118 to yield 8.25% or 87 basis points more than comparable Treasuries.
The issue is rated AAA by both Moody's Investors Serviced and Standard & Poor's Corp's.
A report by Standard & Poor's showed bank reliance on proprietary trading, or trading for one's own account, for a major portion of earnings in increasingly a negative factor in credit assessments.
Standard & Poor's said the increases in volatility of trading income during the first quarter of 1994 has caused the rating agency to reexamine the ratings of major trading banks. In May, the rating of Bankers Trust New York was lowered to AA-minus from AA, and the outlook on J.P. Morgan & Co., rated AAA, was revised to negative from stable because of trading activities.
These banks' trading revenues, both proprietary and market making, account for more than 30% of their total revenue, far ahead of other large U.S. banks, Standard & Poor's said. Proprietary trading, which is the riskiest and most volatile trading activity, has increased significantly at some institutions, the report said.
Until first quarter 1994, trading revenues among U.S. banks arguably exhibited less volatility than traditional lending business. In its analyses, Standard & Poor's said it tolerated an increasing reliance on trading business at banks with higher ratings because of this stability.
However, market volatility in the first quarter led as substantial drop in trading income for U.S. commercial banks, Standard & Poor's said. According to the report, just as the extraordinary trading profits the banks rang up 1993 represented own-account positioning, so the subsequent sharp decline was due to the same activity.
On the other hand, the marketmaking functions - in fixed income, currencies, and derivatives - are valuable franchises for major players like Bankers Trust and J.P. Morgan, Standard & Poor's said, and they usually account for the bulk of total trading profits.
Currently, most trading houses have taken sharply reduced positions. However, when traders begin to discern trends, and when de-leveraging of client positions runs its course, trading profits may once again be more robust, Standard & Poor's said.
