As discussion in the Treasury market moves from whether the Federal Reserve will boost short-term rates to when it will, investors are caught in a rather tenuous position.
No one doubts that the Fed will need to rein in economic growth sometime next year. But the question is how soon the move will come.
Treasury market prices ended lower yesterday on fears that the Fed will boost interest rates sooner than most expect. The 30-year bond closed down more than 1/4 point, to yield 6.29%
Clearly, this issue will dominate today's meeting of the Federal Open Markets Committee, market observers said. The committee, they said, will rummage through a mountain of economic statistics and a barrage of recent statements from Clinton Administration officials to formulate its short-term goal for interest rates.
"The meeting is likely to be one of the most lively in a long time," said Hugh Johnson, chief financial strategist at First Albany Corp.
Market participants remain mixed on whether the Fed will wait until inflation picks up before it tightens credit, or boost rates preemptively to head off higher prices before they appear. The problem facing fixed-income investors in this environment is one of risk management and positioning.
Given widespread expectations of stronger economic growth in 1994, market Participants are less than enthusiastic about owning long-dated Treasury paper.
With short-term rates poised to move higher, conventional wisdom suggests that investors buy Treasuries from the five-year note on out the yield curve. Traders noted that the intermediate sector of the curve attracted a modest amount of buying interest as some players moved out on the yield curve and others moved in to protect their holdings from potential volatility at either end of the curve.
Still, lack of consensus in the market is prompting many players to rein in their holdings of government securities and start 1994 with a clean slate.
"You're looking at a year when tightening is going to be the mode," said Michael Strauss, chief economist at Yamaichi International. "People are adjusting to that, and most are avoiding the market."
Thus, trading opened on a negative note yesterday as the financial press played up the potential for tighter monetary policy. The reports tossed an element of uncertainty into the market and some dealers sold Treasuries.
The burden of new supply further dampened the market's prospects. The Treasury Department will auction $17.0 billion of two-year notes Tuesday, and $11.0 billion of five-year notes Wednesday.
"The market has to absorb two- and five-year notes this week and deal with the likelihood that the Fed will boost short-term rates," one head trader said. "With all this in the week before Christmas, the market is saying bah humbug."
A lack of buyers and the absence of fresh news on the U.S. economy led to extremely thin trading and lent little support to the market.
Instead, the market focused on fears of higher interest rates and unsubstantiated rumors that Fed chairman Alan Greenspan might step down due to poor health. A Fed spokesman said the reports were unfounded and that Greenspan would be present,at today's FOMC meeting.
The Treasury's weekly three- and six-month bill auctions drew tepid demand yesterday at average rates of 3.06% and 3.26%. The bid-to-cover ratios were also lukewarm at 3.80 for the three-month and 3.47 for the six-month.
In futures, the March bond contract ended down 9/32 to 115.23.
In the cash markets, the 4 1/4% two-year note was quoted late yesterday down 3/32 at 100.02-100.03 to yield 4.19%. The 5 1/8% five-year note ended down 7/32 at 99.21-99.23 to yield 5.18%. The 53/4% 10-year note was down 9/32 at 99.16-99.20 to yield 5.80%, and the 6 1/4% 30-year bond was down 10/32 at 99.07-99.11 to yield 6.29%.
The three-month Treasury bill was up two basis points at 3.06%. The six-month bill was unchanged at 3.23%, and the year bill was up three basis points at 3.47%.Treasury Market Yields Monday Prev. Prev. Week Month 3-Month Bill 3.10 3.09 3.136-Month Bill 3.30 3.32 3.301-Month Bill 3.59 3.61 3.502-Month Bill 4.19 4.21 4.213-Month Bill 4.53 4.53 4.595-Month Bill 5.18 5.15 5.197-Month Bill 5.32 5.31 5.4210-Month Bill 5.80 5.75 5.8830-Month Bill 6.29 6.23 6.37Source: Cantor, Fitzgerald/Telerate