The Treasury Department will probably reopen its current 10-year note when it announces its November refunding package today.
The expectation, which grew out of market speculation of a protracted squeeze in the issue, gained credibility yesterday when a Treasury official confirmed that a reopening of the note was under consideration.
Jill Ouseley, Treasury Department director of finance, said it is "possible" that the department may reopen the 53/4% 10-year note. Ouseley said that no definite decisions have been made on re-opening the note, which is part of the Treasury's latest quarterly refunding package. The issue will probably be clarified today when the details of the refunding are released.
Reopening the 10-year note, in theory, would add liquidity to the intermediate sector of the Treasury yield curve and address what many market participants see as a squeeze on the issue. Squeezing a fixed-income security is meant to increase demand for the issue and drive its price up.
The 10-year note has traded special for two months in the overnight repo market, and traders have long speculated that some large accounts were squeezing it. The 10-year has traded as low as a yield of zero in the repo market and has ranged between yields of 0% and 0.5% in the last two weeks of trading.
Scarcity in the 10-year reflects the tidal wave of corporate and mortgage-backed bond issuance in recent months as underwriters scrambled to take advantage of the lowest interest rates of a generation. The overnight 10-year note is a favorite hedging tool of players who invest heavily in these instruments, particularly foreign investors.
While the Treasury has in the past acted to head off squeezes in the repo market, it is rare for the department to admit publicly that it may reopen an issue. Overnight traders interviewed yesterday were confident that the Treasury will announce a reopening of the 53/4% 10-year note today.
"The 10-year shows all the symptoms of a protracted squeeze and has suffered from a severe lack of liquidity," said one head repo trader at a New York-based primary dealer. "It would be a big surprise if they didn't reopen the note."
Fred Leiner, Treasury market strategist at Continental Bank, believes a reopening of the issue would signal to the market that the Treasury is not willing to tolerate squeezes - and it would be a move to add liquidity to the intermediate sector of the market.
"The Treasury has been following a policy where it's not willing to allow squeezes to go unaddressed, and the 10-year has been tight for some time now," Leiner said. "It's likely that they will re-enter the market with more 10-year notes."
Scarcity of the issue in the overnight market has lent support to the cash 10-year note and driven its price higher. However, the current 10-year note has weakened in recent sessions due to speculation that the Treasury might reopen the issue. A reopening of the issue will probably push prices down as there will be more of the issue to go around, and it will probably lose its luster as a hedging tool, market participants said.
Tuesday Market Activity
Treasury prices weakened yesterday as more evidence of strength in the U.S. economy emerged and sent investors running for cover.
The 30-year bond ended the session down 10/32, to yield 6.05%.
News from the housing sector painted an even brighter picture of economic activity that most economists had predicted and slammed the door on the recent Treasury market rally.
Sales of new single-family homes surged 20.8% in September to a seasonally adjusted annual rate of 762,000 units, the Commerce Department reported.
The increase far exceeded analysts' expectations for a gain of about 5.0% and was the highest level for home sales since December 1986 when sales were at a 784,000 unit rate. Aside from the Northeast section of the country, gains were posted in all regions, particularly in the South where sales surged 27.9%.
Analysts warned that the report probably overstated the health of the housing sector, noting that the seasonally adjustments may have over compensated. For example, economists said that on an unadjusted basis, home sales in the West were unchanged. But seasonally adjusted, sales in that region rose 15%. A similar argument can be made for the Midwest, the analysis said.
Still, economists interpreted the numbers as unequivocal evidence that interest rate sensitive sectors of the economy are finally benefiting from the lowest rates in 25 years.
"This is an eye-popping number," said Steven Wood, director of financial markets research at BA Securities Inc. in San Francisco. Wood was encouraged by the broad-based gain in sales activity and noted that the report. coupled with other signs of buoyancy in the economy, is posing problems for the credit markets.
"The market has not liked the string of economic statistics we've had recently," Wood said.
The market was greeted with another Commerce Department report yesterday which provided further evidence of the economy's steady growth track. The index of leading indicators gained 0.5% in September, the third increase in four months.
Market observers said the rise in the index shows that the economy continues to display signs of improvement, but noted the data holds little fresh information.
In other data, U. S. department and chain store sales rose 0.9% on a seasonally adjusted basis in the first four weeks of October versus September, the Johnson Redbook Service said.
Seasonally adjusted sales for the first four weeks of October were up 8.3% more than a year ago.
Cumulatively, the economic statistics sparked a selling wave that extended losses posted in recent trading sessions. Most significant about yesterday's sell-off is that it was not speculative in nature, as had been the case in recent sessions. Selling yesterday came primarily at the hands of retail investors who were liquidating long positions.
The market made a halfhearted attempt to recoup losses by covering short positions, but the uptick in prices was not met with significant buying interest and prices began to erode once again.
The question bouncing around the market in recent sessions is whether recent signs of strong economic activity will prompt the Federal Reserve to tighten policy.
While market participants generally believe that the central bank will need to reign in economic growth sometime down the road, most think a rate hike is unlikely before the second quarter of 1994.
Brian S. Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson in Chicago, argued that growth will experience fiscal contraction in coming months as tax increases work their way through the economy and that the Fed will hold steady to observe the impact on economic fundamentals.
One sure sign that market sentiment has turned negative is the poor performance of the short end of the yield curve, represented by the two-year note.
Because steady federal funds rates have kept the two-year note locked around a 4% yield level in recent months, any backup in interest rates in recent weeks has been met with strong buying interest. But in recent sessions, the issue has failed to drum up support, even with a yield well above 4%.
As the debate over the direction of the economy rages on, the market is trying to locate a comfort zone where it can tolerate stronger economic growth. Participants are bracing for the prospect of 4% growth or higher in coming months plus government-induced inflation as tax increases and health-care reform take effect. Until a level is agreed upon by the marketplace, Treasuries are in a rather tenuous position.
Holding some large players in the Treasury market at bay, notes Wesbury, is the positive inflation environment. While the market has clearly shown its displeasure for strong news on the economy, he believes the real sell-off will occur when inflation raises its ugly head again.
"None or the classic inflation indicators is showing significant price pressures, and that's what the market needs to keep in mind," Wesbury said.
In futures, the September contract ended down 30/32 to 116.21.
In the cash markets, the 37/8% two-year note was quoted late yesterday down 1/32 at 99.15-99.16 to yield 4.13%. The 43/4% five-year note ended down 2/32 at 98.26-98.28 to yield 5.00%. The 53/4% 10-year note was down 10/32 at 101.00-101.04 to yield 5.59%, and the 61/4% 30-year bond was down 10/32 at 102.17:102.21 to yield 6.05%.
The three-month Treasury bill was up five basis points at 3.12%. The six-month bill was up five basis points at 3.28%. and the year bill was up three basis points at 3.43%. Treasury Market Yields Prev. Prev. Tuesday Week Month3-Month Bill 3.12 3.09 3.016-Month Bill 3.29 3.19 3.131-Year Bill 3.43 3.31 3.252-Year Note 4.13 3.89 3.843-Year Note 4.40 4.17 4.125-Year Note 5.00 4.74 4.707-Year Note 5.21 4 94 4.8810-Year Note 5.59 5.38 5.3230-Year Bond 6.05 5.97 6.00