Short-term Treasury prices deteriorated Friday in response to the surprisingly robust retail sales report, and the sell-off at the short end caused the yield curve to flatten.
The 30-year bond closed 1/8 point lower, where it yielded 7.43%, and note prices were off as much as 3/8 point.
The flattening took place during a shortened trading session. The cash Treasury market closed early Friday, at 1 p.m. eastern standard time, because a storm was wreaking havoc on New York City's trains, subways, and ferries.
Traders said activity was limited even before the early close because the weather kept some New York participants from getting to work in the morning.
Most of the price decline occurred right after the market saw the November retail sales report.
November retail sales rose 0.4%, which was only a little higher than the 0.2% gain the market had been expecting. The real surprise was the upward revisions to previous months.
September's gain rose to 0.7% from 0.5%, and October's increase was revised up to 1.9%, more than double the 0.9% reported last month.
Analysts said the strength in October retail sales means fourth-quarter growth could be significantly higher than the 2% rate economists had expected.
"The upward revisions to September and especially October were pretty large," said Paul Lally, an economist at R.H. Wrightson & Associates. "That suggests consumer spending didn't lose very much steam going into the fourth quarter and implies that fourth-quarter growth is going to be substantial."
Lally said fourth-quarter growth might come in at about 3%, which compares with the 3.9% third-quarter gain.
David Wyss, chief financial economist at DRI/McGraw-Hill Inc., said he had been predicting a 2.1% rise in fourth-quarter gross domestic product, but now thought an increase of about 3% was more likely. He cautioned that it was too early to make a definitive forecast.
Friday's price action mirrored what had happened Thursday: While the notion of better-than-expected growth battered short-term prices, good news on inflation moderated losses at the long end.
Analysts said Friday's November consumer price index was not as favorable as Thursday's 0.2% drop in producer prices, but still provided reassurance that inflation is not a problem right now. November consumer prices rose 0.2%, and the core rate, excluding food and energy costs, was up 0.3%, in line with economists' predictions.
"We're at about a 3% annualized growth rate, and a little higher on the core," Lally said. "That's a full percentage point under the average for the past five years and a low enough inflation rate that you can just forget about it when making business plans, which is apparently what the Fed is shooting for."
Later Friday, the market got another bit of unfriendly news when the University of Michigan told subscribers its preliminary index of December confidence had risen to 91.4 from 85.3 in November.
By Friday's close, the long end's better performance had diminished the 30-year bond's yield advantage over the two-year note to 269 basis points, down from 277 late Thursday and 284 Wednesday.
Traders said the healthy economic news was not the only problem for the short end. Supply is also looming, in the form of next week's two- and five-year note sales.
Even though those issues are sold every month and usually go smoothly, traders worry that the thin yearend conditions will be a problem for this set of sales.
Frederick Leiner, a market strategist at Continental Illinois, said the bond market's recent behavior shows it is beginning to adjust to the notion of an economic recovery.
"The market is saying 2.5% to 3% economic growth isn't that bad," Leiner said. "We've got plenty of slack in the economy, inflation isn't going to be a problem, and [the better growth] gives the new administration a chance to do something about the deficit."
This week's economic indicators are not that exciting, and Wyss said the bond market will focus instead on President-elect Bill Clinton's economic policy summit today and tomorrow, although the meeting is unlikely to produce any real decisions.
He said Wednesday's november Housing starts report would be interesting. "Lousy weather will hurt Northern starts, but the rebuilding from Hurricane Andrew should adds some starts down in Florida," he said.
Charles Lieberman, a managing director of Chemical Securities, thinks Thursday's October trade balance will be the week's key report.
The Bundesbank indicated last week that it is not ready to ease policy, and as long as European interest rates remain high, economies there will suffer, Lieberman said. "That ensures the U.S. trade account will worsen, because we can't sell more if they're buying less."
The March bond futures contract closed 1/8 lower at 104 4/32.
In the cash market, the 7 5/8% 30-year bond was 1/8 lower, at 102 5/32-102 9/32, to yield 7.43%.
Treasury Market Yields
Friday Week Month
3-Month Bill 3.30 3.32 3.13
6-Month Bill 3.49 3.45 3.43
1-Year Bill 3.80 3.70 3.65
2-Year Note 4.74 4.69 4.58
3-Year Note 5.24 5.24 5.14
5-Year Note 6.08 6.08 6.02
7-Year Note 6.44 6.46 6.44
10-Year Note 6.79 6.81 6.81
30-Year Bond 7.43 7.48 7.57
Source: Cantor, Fitzgerald/Telerate
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