Prices of government securities tumbled yesterday as a weaker-than-expected report on the U.S. international trade deficit pressured the dollar.
The market recovered some of its early losses as investors sought to cover short positions in the afternoon, but the overall tone of the market was bearish and sellers dominated. After being down over 1/2 point at midmorning, the benchmark 30-year Treasury bond closed down nearly 1/4 point, to yield 7.77%. The market got off to a bad start when the Commerce Department reported that the U.S. international trade deficit hit $10.99 billion in July, a whopping 21.6% increase from a revised $9.04 billion in June. The increase far exceeded most economists' expectations, which generally hovered in the $9.6 billion range. Compounding the negative implications of the report, the U.S. bilateral trade deficit with Japan increased 2.7% in July to $5.67 billion, its highest level since March.
"Continuing deterioration in trade when expectations are that trade should improve poses a risk to the dollar, and markets react nervously," said Allen Sinai, chief economist at Lehman Brothers.
In late trading yesterday, the dollar was quoted at 97.60 Japanese yen and 1.5510 German marks, compared with 98.42 yen and 1.5475 marks the previous day.
Sinai deemed the trade report "damaging to the dollar and damaging to the fixed-income markets," but added that "although the trade deficit has deteriorated, the reversal of that trend is not far away. And the damage to the dollar will be limited."
However, the potential for a larger swoon in the dollar had Treasury market traders wary yesterday -- and could ultimately help prod the Federal Reserve to tighten monetary policy again.
Many market players and economists are expecting another tightening of the Fed's credit policy to emerge from its next Federal Open Market Committee meeting on Sept. 27, or at least soon thereafter.
"There is good enough reason for the Fed to tighten on Sept. 27 in terms of fighting future inflation," Sinai said, noting that he believes it is not a foregone conclusion.
Sinai predicts that if the Fed does move, it will tighten by only 25 basis points, but other sources are suggesting a 50 basis point move is more likely.
Between now and next Tuesday, however, there are few economic numbers for government securities players to trades on, and the market is expected to remain in a fairly tight range, with the yield on the 30-year bond hovering between 7.75% and 7.90%.
One possible factor that could upset the lull ahead of the FOMC meeting next week is "anything that might make the trade talks with Japan look like a dead end," which would leave the dollar even more vulnerable, Sinai said.
Ominously, perhaps, James Hackney, counselor to U.S. Secretary of Commerce Ron Brown, said yesterday that he remains "concerned" about progress in trade negotiations between the United States and Japan. The United States has hinted that it might impose trade sanctions on Japan by the end of September if an agreement is not reached.
The next batch of economic news that will really move the market will not occur until the first week of October, which brings the National Association of Purchasing Managers index and the September employment report.
On tap for today is a report on housing starts for August, which most economists predict will be down slightly from the 1.43 million annual rate in July. David C. Munro, chief U.S. economist for High Frequency Economics, a daily summary of market indicators, expects a 2% slowing, "based on the less-than-dramatic hints of retreat in the beige book."
A slight decrease in housing starts will probably not provide enough of a boost to lift the market out of its current funk. But a higher-than-expected figure could portend further losses, according to Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp.
"Housing starts potentially could have an impact, [but] I'm afraid the number may have more downside risk than upside, because everyone is under the assumption that the housing sector has plateaued," said Schaja, who is predicting a very slight increase for August.
A $1.5 billion issue of global bonds by the World Bank highlighted yesterday's corporate issuance.
The bonds were priced at 99.471 as 7 1/8s to yield 7.253%, or nine basis points above the yield on the five-year Treasury note.
A group led by Lehman Brothers and UBS Securities brought the offering, which was rated triple-A by both Moody's Investors Service and Standard & Poor's Corp.
In the secondary market for corporate securities, traders said spreads on high-yield securities were mixed in light trading, while investment grade securities fell from 1/8 to 3/8 in sympathy with Treasuries. !!! Begin table
Treasury Market Yields
3-Month Bill 4.71 4.69 4.67
6-Month Bill 5.27 5.16 5.10 1-year Bill 5.78 5.63 5.61 2-Year Note 6.40 6.31 6.19 3-year Note 6.70 6.60 6.53 5-Year Note 7.12 7.02 6.92 7-Year Note 7.33 7.21 7,10
10-Year Note 7.51 7.40 7.28
30-Year Bond 7.77 7.67 7.56 !!! End table
Source: Cantor, Figtzgerald/Telerate