TALK FROM THE TRENCHES: US TREASURIES HEAD SOUTH ON FED FEARS
By Isobel Kennedy
NEW YORK (MktNews) - U.S. Treasury prices headed south Tuesday on the stronger than expected retail sales figure. And while the down move has been achieved on relatively light volume, the market is still very spooked about the Fed.
Even though Tuesday's consumer price index showed inflation to be benign, there are players who think the Fed will move to a tightening bias at the Dec. 21 FOMC meeting. One reason for that would be to assure that the Fed is are not perceived to be behind the curve, market sources say. In addition, it would prepare the street for a rate hike at the Feb. 1-2, 2000 meeting, the first in the new year.
Others say the Fed would not announce a tightening bias at the late-December meeting for fear of roiling the markets just when Y2K disruptions might occur. And the Fed certainly would not actually raise rates either, even though some think Fed officials would love to raise them in December but can't because of Y2K.
Of course, as we pointed out last Friday, the Fed does not have to have a tightening bias in place to tighten. At the Aug. 24 meeting, the Fed raised the fed funds rate and the discount rate 25 bps each when there was a neutral bias in place.
Speaking of the Fed, a senior market strategist contends the 2/10Y curve may flatten another 3 bps to 5 bps to around 11 bps while the 2/30Y could narrow to around 19 bps. Upcoming supply in 2s and concerns of the Fed moving to a tightening bias at the Dec 21 FOMC should weigh on the front end.
Also helping the back end are expectations that the recent trend of moving cash out of bills and short coupons into longer paper will continue.
On the other hand, there is evidence that some European central banks have been reversing this trade. There are reports they bought 3- and 6-month bills on a outright basis or vs. selling coupons on Tuesday. Last week, those same accounts were selling short bills and moving into EMU-11 paper or off-the-run 5s or 10s.
Some other analysts are looking for the curve to steepen if prices decline further. While the 2/30Y curve is expected to remain largely unchanged into year-end, 2/10Y is anticipated to widen back out to around 20 bps. Strategists add that the 5/10Y flatteners and the 5/10/30Y butterflies that were put on last week should remain in place for now.
There is also a debate about Y2K flight to quality buying. Some say any Y2K flight to quality buying of Treasuries may actually take place in intermediates and the back end. Potential Fed tightening, lack of inflation and a flat yield curve means those sectors could perform better than the short end.
Still, others take a more traditional view. They say if flight to quality buying does occur it will happen in the bill sector where safe haven buying always occurs.
Back to the Fed. Some shops who are calling for two rate hikes in the first half of 2000 think the two-year note will back up to 6.25% over that same timeframe. It got as cheap as 6.05% Tuesday vs. the 1999 intra-day high yield of 6.064%.
But despite a bearish outlook for the short end, some players are unwilling to short the issue unless they find evidence the Fed has a lot "bigger job to do" going forward.
On Wednesday, the size of this month's two-year note will be announced. Early forward opening roll talk ranges from a slight give up in yield to a pick up of 1.5 bps. Players looking for a give up say demand to move into the WI 2Y should be decent because the November issue is a double issue with $28.3B outstanding.
However, traders looking for a pick up in yield say there is concern "nobody will show up for the auction" because the new two's are scheduled to settle on Dec 31. Portfolio managers may be content to sit with their November 2Y positions until the first week of Jan after Y2K concerns dissipate, they add.
Other negatives for the issue are the fact that many people are sidelined for the year anyway. And fear of Y2K disruptions is just aggravating the normal year end slowdown.
By the way, with Tuesday's release, the current account is running about 3.9% of U.S. gross domestic product. Prior record was set in 1987 at 3.5% of GDP.
You can be sure the Fed is watching these numbers for its effect on the dollar and how this deficit is funded. Remember, it was New York Fed President William McDonough who said in late November that the current account deficit was the main reason the Fed raised rates in November.
Tuesday's numbers show foreigners bought $24 billion of U.S. equities in Q3, down from $29 billion in Q2. Excluding U.S. Treasuries, they bought $69 billion of other corporate and U.S. agency debt, up from $50 billion in Q2.
Looks like a New York State judge has imposed a temporary restraining order on New York City transit workers who were planning to strike at midnight Tuesday night. Does that mean the commute will be normal tomorrow? Cynical New Yorkers, who are always braced for the worst, are still thinking about how they will get to work if a strike occurs. Bicycle? Walk over the Brooklyn Bridge? Hail a cab? Getting a cab is rough on even the best of days. Good luck. --Rob Ramos contributed to this report.
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. |
