TALK FROM TRENCHES: FED SLIPS THE NOOSE AROUND US TSYS
By Isobel Kennedy & Rob Ramos
NEW YORK (MktNews) - U.S. Treasury prices are mixed Wednesday. Prices remain in a very tight range with the short end a little softer and the longer end a little firmer vs. yesterday's 3 p.m. ET levels.
Despite the fact that the market has basically managed to hold in and not break out of the recent range, there have been few positive comments about yesterday's Fed message.
One veteran salesman said the Fed's tightening bias has the market in a noose. "Fear of the unknown is something Bond Daddies can't survive on." He also says Friday's employment report will only cloud the waters and "worse yet it may give false hope." (We know "Bond Daddy" is politically incorrect but it's a useful phrase that fits).
Yesterday's change in bias to tightening leaves the market in "limbo", another says. The market is on hold, unable to move forward with any intensity or conviction because retail is on a "buyers strike" and the Street is innately bearish, others say.
Several treasury players say the bond and stock markets had already been tightening for the Fed and after yesterday's announcement of a bias to tightening they will continue to do so. They say the Fed is keeping the financial markets under wraps going into year end and that saves them from actually raising rates and aggravating Y2K concerns.
Players do look for some retracement of yesterday's 1-1/4 point drop in long bonds. But speculative and trading accounts also appear poised to sell into any strength ahead of Friday's employment report.
Sources say any real money spending is going into agency paper. Agency spreads were unchanged after the Fed's bias change yesterday even though U.S. yields backed up to early August levels. They are tighter by 1-2 bps again this morning. Sources have reported seeing steady buying of agency paper Wednesday. And keep in mind the story from earlier in the week that Japanese accounts have been buying agencies because they do not have to mark them to market.
One strategist says yesterday's policy statement provided fodder for both bulls and bears but leaves the market looking at the tea leaves again. "The FOMC resolved little and the dark tightening cloud remains over the market and will likely remain there until the economy finally slows."
Some economists say their preliminary forecasts for key economic reports that will be released before the next FOMC meeting will be "enough evidence" for the Fed to tighten on Nov 16. Some say the Q3 employment cost index and advanced Q3 GDP, both to come out on Oct 28, will be key.
Moody's says the outlook for Treasury bonds has worsened. It says the U.S. equity market withstood a shockingly steep ascent in bond yields which is bad for bonds. The report also says "we could be seeing the sharpest acceleration of global economic activity since 1994."
Traders in London are taking the view that the rise in long U.S. Treasury yields following the FOMC tightening bias is making the U.S. equity markets vulnerable to further falls and hence is particularly negative for the dollar against the euro.
While many traders seem to have raised their expectations for a European Central Bank rate hike since the weekend, several remain in the "no hike" camp, citing ongoing patchy economic growth in Euroland, particularly in the area's largest economy, Germany. While France and Ireland among others appear to be enjoying solid growth, the German economy has yet to show the same level of energy they say, arguing against a hike at the present time.
The ECB is seen keeping official interest rates unchanged at Thursday's Governing Council meeting, Market News International understands from high-level contacts with one of the euro-zone central banks. And the prospects of an interest rate hike by the ECB before the end of the year can be excluded in the absence of dramatic new developments, MNI also understands based on this channel of information. It should be pointed out that the central bank concerned is among the euro-zone countries, which are not enjoying strong growth and can explain their current attitude, say analysts.
Japan's FM Miyazawa said Wednesday that a meeting of finance ministers and CB governors from the G-7 powers, slated for next February, will be held in Tokyo, and joint currency intervention to weaken the yen is still on the agenda, according to Kyodo News. Market players said Miyazawa's suggestion of joint intervention still being on the agenda seems to hint at an agreement already in place. Last week, rumors abounded in Europe that a CB agreement had been made to defend the dollar at the Y103 level.
JGBs collapsed Tuesday when LDP policy chief Kamei said that the upcoming stimulus package would be more than 13 trillion yen, larger than what the market was expecting. It also means they will have to sell much more debt.
Wednesday, the Fed did overnight system repos to include agencies, mortgages, and governments in a new tri-party settlement. This is the new Y2K liquidity arrangement that officials asked for final dealer comments on, due Monday. Use of the new arrangements suggests the FOMC okayed it at yesterday's meeting.
Perhaps the most important item in this article today is the sad news that the Bond Market Association did not recommend a full close for New Year's Eve on Dec 31. We humbly apologize for our mistake and for the disappointment we have surely caused!!
NOTE: Talk From the Trenches is a daily compendium of chatter from Treasury trading rooms offered as a gauge of the mood in the financial markets. It is not hard, verified news.
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