The Federal Reserve's failure to cut interest rates yesterday sent Treasury prices lower and resulted in an unpopular seven-year note sale, which in turn depressed prices even more.
By late in the day, short-term and intermediate notes were 1/4 to a full point lower, and the 30-year bond was off 7/8 point to yield 7.48%.
Bond market participants had expected the Federal Reserve to cut both the discount and federal funds rates in the wake of a series of weak economic reports, including last Friday's 57,000 decline in September nonfarm payrolls.
The market's hopes for easing began to fade on Tuesday, when the Fed remained silent after the Federal Open Market Committee meeting ended, and disappeared entirely yesterday, when the Fed again failed to signal any chance in policy.
Analysts regarded yesterday as the Fed's last clear opportunity to ease until after the presidential election on Nov. 3.
Jerry Gluck, an economist at Mitsubishi Bank, said the Fed's failure to act yesterday "kills any chance for a cut in the discount rate or the funds target until after the election.
"They have plenty of indications the economy is still weak; there's no need to wait for more data," Gluck said. "But apparently, they're worried about the weakness of the dollar and the proximity of the election."
Kevin Logan, chief economist at Swiss Bank Corp., said Fed policymakers probably adopted a bias toward further easing at Tuesday's Federal Open Market Committee meeting, but said he doubted the Fed would change policy from now until November.
"I don't see what more information we'd get on the economic scene that would lead them to change their mind" before the election, he said.
Treasury prices moved steadily lower during the morning as participants liquidated securities in response to the Fed's inaction and also in preparation for the seven-year note sale.
The market sold off more during the afternoon when the auction results showed that dealers and investors had shunned the seven-year notes.
The $9.75 billion of seven-years were sold at an average yield of 6.01%, instead of the % or 5.99% traders expected.
And the Treasury accepted yields all the way up to 6.05% in order to distribute the securities, indicating that the bidding had been quite sloppy. The Treasury awarded 20% of the bids entered at the high of 6.05%.
The issue will bear a 6% coupon. The 6.11% average yield was the lowest at a seven-year auction since the Treasury began selling that maturity in 1978. In comparison, the average at the last seven-year auction in July was 6.44%.
"The seven-year was really a dud," said William Griggs, a managing director at Griggs & Santow Inc.
"This is just an issue that came at the wrong time," Griggs said. "Things are too unsettled, nobody wanted supply, and it's not an issue that's popular anyway."
Griggs said the seven-year notes were also competing with the heavy corporate issuance in the intermediate area.
Other details of the auction results were similarly discouraging. Bids totaled $19.6 billion, or only twice the size of the issue, which is a little below average for a seven-year sale. In addition, there were only $324 million of noncompetitive bids, down from $591 million at the July auction.
The head of a Treasury trading desk said that if he were grading the seven-year auction, he would give it a D.
"We just don't have legitimate interest in the market here," he said. "People have taken one step back, and it reflected itself in the auction."
The desk head said the unsettled condition of the corporate market in the wake of Marriott Corp.'s restructuring was another problem for intermediate Treasuries.
Earlier this week, Marriott said it would reorganize itself into two companies, one of which holds most of the corporation's debt. The announcement boosted Marriott's stock, but depressed the price of its bonds, and bondholders fear other companies will follow suit.
"Event risk has been injected into the corporate market again," the desk head said. "Until things get cleaned up there, there's a tremendous amount of hedging pressure" on the Treasury market.
The desk head said the Treasury market's next move depends on technical factors. "To get any meaningful bounce, we'll have to develop a short base," he said.
A bill trader was more pessimistic about prices at the short end. With funds stuck at 3%, the cost of financing positions overnight will remain around 3.10%, which means dealers are losing money financing their bill inventories, the trader said.
"Basically, the front end has a way to go to get fairly priced to funds," he said, adding that he expects the prices to adjust to the funds level over the next couple of weeks.
The December bond futures contract closed 31/32 lower at 103 30/32.
In the cash market, the 7 1/4% 30-year bond was 27/32 lower, at 97 4/32-97 8/32, to yield 7.48%.
The 6 3/8% 10-year note fell 1 5/32, to 99 13/32-99 17/32, to yield 7.48%.
The three-year 4 5/8% note was down 14/32, at 100 23/32-100 25/32, to yield 4.32%.
In when-issued trading, the 6% seven-year note was bid at 6.04%.
Rates on Treasury bills were higher, with the three-month bill up eight basis points at 3.82%, the six-month bill up seven basis points at 2.92%, and the year bill eight basis points higher at 3.02%.
Treasury Market Yields
Wednesday Week Month
3-Month Bill 2.85 2.72 2.96
6-Month Bill 2.98 2.90 3.02
1-Year Bill 3.11 3.04 3.15
2-Year Note 3.85 3.78 3.83
3-Year Note 4.32 4.25 4.31
5-Year Note 5.39 5.32 5.24
7-Year Note 5.99 5.88 5.80
10-Year Note 6.43 6.34 6.32
30-Year Bond 7.48 7.37 7.24
Source: Cantor, Fitzgerald/Telerate