Treasury note and bond prices were sharply higher yesterday morning, but uncertainty about the nation's monetary policy mixed as retail profit taking dragged prices lower.
The government market got an overnight boost after the Bundesbank, Germany's central bank, cut its discount rate 50 basis points to 8 1/4%, and the Lombard rate, equivalent to the Fed funds rate, 25 basis points to 9 1/2%.
London-based traders said the move gave the dollar a boost and placed the U.S. Federal Reserve in a better position to cut the discount rate by 50 basis points, and lower the funds rate an additional 25 basis points.
With that news in hand, government note and bond prices spiked to as much as 3/4 point higher, with the yield on the long bond bottoming out at 7.23%.
As the day wore on, the rationale for the Bundesbank's cut caused concern in the government market.
"One reason that the German bank may have enacted the cut was to begin the process of stimulating global economic growth," said William Sullivan, senior vice president and director of money market research at Dean Witter Reynolds Inc. "This created some concern for the Treasury market."
"The move cleared the way for the Fed to act." said a London bond trader. "But I suspect that more weak economic news is needed for that to happen."
There were no major economic releases yesterday, and the Fed continued along a cautious path before today's slate of economic releases.
This morning, August retail sales and the August consumer price index are released.
Eleven economists surveyed by The Bond Buyer said that retail sales should be unchanged for the month and consumer prices will rise only 0.2% total and 0.2% at the core minus food and energy costs.
"Those numbers suggest that the economy is still performing very sluggishly," said Paul Kasriel, economist at Northern Trust Securities Inc. "If the numbers come in like that, then the Fed will certainly have the opportunity to ease. "
Mr. Kasriel said many investors were surprised by the Fed's last funds rate cut. He maintains there are two factors suggesting further easing.
"First of all, the last ease really had no effect. The banks didn't cut their prime rate and the markets did not react," he said. "Secondly, there is no crime in the Fed lowering the funds rate to 2 3/4%, and then raising it soon after."
Mr. Sullivan continued, "The real question about the next Fed action is not so much if, but when, they will act. They may choose to keep their powder dry until the October round of indicators kicks in."
Both Mr. Sullivan and Mr. Kasriel said the longer the Fed holds off on another move, the greater the chances are the next ease could be a 50-basis point cut for both the funds and the discount rate.
"With the next cut, the Fed would definitely want to produce a lowering of the prime rate," said Mr. Sullivan.
Mr. Sullivan said, though, that the next move by the Fed "would probably" be a 25 basis point cut in the funds rate, and 50 basis points on the discount rate.
Mr. Kasriel said that by refusing to act more aggressively immediately following the August employment numbers, the Fed may have "dug itself into a very dangerous hole. "
"It's very difficult to understand the mind of the Fed," he said. "With the dollar showing renewed vigor, U.S. exports will be weaker, and drag the economy further down. They may have no choice but to case. "
Mr. Kasriel warned that the current unpredictability of the dollar's performance makes it an unreliable benchmark for monetary decisions.
Mr. Sullivan said another factor capping the gains made in the Treasury market is the uncertainty of the November presidential election.
"With his re-election in doubt, President Bush is akin to a drunken sailor on liberty." he said. "All means of fiscal stimulus are being investigated before the election."
The Treasury sold $21.26 billion of 91-day and 182-day bills yesterday, as the three-month bills incurred an average rate of 2.89%, down from 2.91 % in the previous auction - the lowest since the average of 2.88% on April 22, 1963. The six-month bills incurred a 2.90% rate, down from 2.95% - the lowest since the average of 2.86% on Dec. 10, 1962.
A note trader said that the Treasury market got off to "a rollicking start," but then settled down after the Fed announced no major shift in policy, by offering three-day system repurchase agreements when funds were trading at 3 3/16%.
"We really died after noon," said the head of a trading desk. "We settled into a range and there were very few blocks moved after that."
"Although we came off our highs, the market still had a firmer tone," the note trader said. "Most of the selling was done by retail investors."
The December bond futures contract closed up 12/32, to 106 9/32.
In the cash market, the 7 1/4% 30- year bond was 14/32 higher at 99 27/32-99 31/32, to yield 7.25%.
The 6 3/8% 10-year note rose 3/8, to 100 12/32-100 16/32, to yield 6.30%.
The three-year 4 5/8% note was up 1/4, at 100 29/32-100 31/32, to yield 4.26%.
Rates on Treasury bills were lower with the three-month bill down three basis points to 2.94%, the six-month bill was down four basis points to 2.97%. and the year bill was down six basis points to 3.09%.
Treasury Market Yields
Monday Week Month
3-Month Bill 2.94 2.95 3.11
6-Month Bill 2.97 3.00 3.24
1-Year Bill 3.09 3.11 3.36
2-Year Note 3.76 3.78 4.06
3-Year Note 4.26 4.25 4.62
5-Year Note 5.24 5.18 5.49
7-Year Note 5.80 5.74 6.03
10-Year Note 6.30 6.28 6.52
30-Year Bond 7.25 7.21 7.35
Source: Cantor, Fitzgerald/Telerate