Credit Markets: Economic Weakness May Help Fuel Interest in Bonds
July 23, 2001
By ANDREW GELFAND and MICHAEL S. DERBY
Dow Jones Newswires
NEW YORK -- This week may offer some confirmation that perhaps the worst for the economy wasn't as bad as people had thought.
But though that may prove to be the case, the news need not be bad for the bond market, participants said. While expectations for the second-quarter gross domestic product, due for release Friday, have improved, that report on the nation's total value of goods and services won't show a robustly growing U.S. economy.
Continued economic weakness will keep interest glued to the safe and stable investment of government bonds, while participants wait to see if the Federal Reserve's rate-cutting and the soon-to-be issued tax rebate checks do, in fact, power an expected return to growth later in the year.
Government bond yields, which move inversely to price, fell last week, as the market was cheered by the first leg of Federal Reserve Chairman Alan Greenspan's monetary policy address before Congress.
He told members of a House committee that "the period of subpar economic performance ... is not yet over, and we are not free of the risk that economic weakness will be greater than currently anticipated and require further policy response." But he also expressed optimism over growth, saying that "we are seeing signs that the bottom is beginning to structure itself."
1See more information on bond trading from Briefing.com.
Economists expect Friday's release of the second-quarter GDP report (which is usually subject to notable revisions) to stand at around 1%, vs. the first quarter's weak 1.2%.
Friday's GDP number has been the "hardest to forecast in a while, due to such a big discrepancy between the consumer sector and business investment," said Ethan Harris, co-chief U.S. economist for Lehman Brothers in New York.
While the second-quarter number should be weak, many economists' estimates of it improved last week. That suggests the quarter that many expected to have been the worst in the current slowdown may not have been quite so bad, meaning that the U.S. looks likely to have escaped a recession in the technical sense that it won't experience two consecutive quarters of a contraction in economic activity.
"I do think [the second quarter] will be the weakest quarter. ... It's going to be in a tug of war" with the first quarter, said Gemma Wright, director of market strategy with Barclays Capital in New York. And that continued evidence of sluggish growth is likely to cheer the government bond market and pull in some buying into the relatively attractive intermediate-date part of the yield curve, she said.
Michael Ryan, senior fixed-income strategist for UBS PaineWebber in New York, said "a stronger-than-consensus [GDP] number could force repricing" in Treasury securities even though some market participants dismiss its importance due to the backward-looking nature of the data.
But if the number is weaker than the lower predictions, government bonds may be able to capitalize on that, and rally strongly. "A negative number puts a lot of pressure on the Fed to ease more [by] causing concern in consumer confidence that recession is developing and how effective tax cuts will be," said Richard Gilhooly, senior bond strategist for Paribas Capital Markets in New York.
And well before the GDP data are released, the market will yet again have testimony from Mr. Greenspan to chew on.
Having addressed the House with his semiannual testimony last week, Mr. Greenspan will present the Fed's views on the state of the economy before the Senate Tuesday. Details of his prepared testimony should remain unchanged, but the question-and-answer period could produce some reaction in the market.
Some observers note that the structure of the Senate committee, now controlled by Democrats, may allow for a more pointed questioning of Mr. Greenspan than was seen in his visit before the Republican-led House.
As was the case last week, the X-factor will be how the equities market performs in the midst of corporate earnings announcements.
With significant economic indicators not being released until the end of the week, market participants will turn their attention to stocks, said fixed-income strategists. Companies giving earnings reports include the widely held Lucent Technologies Inc. as well as Texas Instruments Inc. and Compaq Computer Corp.
Stocks "played the total role" last week and will this week, Mr. Gilhooly of Paribas said.
Other data helping to determine the depths of the current economic low are the employment-cost index, durable goods, and weekly jobless claims Thursday, and existing and new home sales Wednesday and Friday, respectively.
Friday's Market Activity
Prices of U.S. government securities were flat to slightly lower Friday, as modest buying related to stock-market weakness was mitigated by some selling by traders booking profits after a strong week for the Treasurys market.
The benchmark 10-year note was down 5/32 at 99 to yield 5.112%. The 30-year bond was down 9/32 at 97 15/32 to yield 5.532%.
The five-year note was down 2/32 at 99 27/32 to yield 4.631%, while the two-year note was off 1/32 at 99 27/32 to yield 3.925%.
Market watchers said trading activity was quiet Friday, given the lack of fresh economic data and exhaustion in the market following a hectic week. Trading volume was about 70% of the five-day moving average, according to International Finance Review.
"The only action we've really had was some profit-taking. There was a very nice rally [last] week, and not everyone is convinced that current economic conditions warrant the market's current levels," said James Caron, fixed income strategist at Merrill Lynch in New York.
The profit-taking mitigated some of the support that bonds were gleaning from a weak day in the stock market, where fallout from some poor earnings reports whipped prices around. With little additional stimulus to drive trading Friday, the market wasn't able to draw in so-called retail investors such as mutual funds and pensions.
High-yield, or junk, bonds were mostly unchanged Friday with the market focusing on new deals lining up for this week.
The main event scheduled is a U.S. Steel LLC $350 million seven-year offering being brought to market by Credit Suisse First Boston.
Proceeds will be used to repay indebtedness attributed to U.S. Steel by parent USX-U.S. Steel Group, from which U.S. Steel expects to be spun off later this year.
Separately, PacifiCare Health Systems Inc. is slated to offer $600 million of 10-year senior notes via Morgan Stanley and Banc of America Securities. Early price talk on that deal indicates a yield of about 12%.
During Friday's session, Boyd Gaming Corp. sold $200 million of eight-year notes to yield 9.50% via Deutsche Banc Alex. Brown and Lehman Brothers.
Boyd Gaming was one of three gaming companies to sell junk bonds during the week, and analysts said the rush to market is indicative of investor confidence in the sector. "Gaming companies have performed well all year," said Jane Pedreira, an analyst at Lehman Brothers. "They're getting a very favorable response from investors, who view gaming as a safe haven given the earnings disappointments that have come to characterize other areas of high yield."
Separately, Vanguard Health Systems Inc. sold $300 million of 10-year notes to yield 9.75% via Morgan Stanley and Banc of America.
Hong Kong's Pacific Century CyberWorks Ltd. scrapped plans to launch an offer of 10-year bonds amid tough market conditions, an underwriter said.
After having been heralded in its early stages as the largest U.S.-dollar corporate bond issue to come from Asia, the deal hasn't yet delivered on the promise. Investors had expected the telecommunications and Internet company to sell at least $2.5 billion of bonds, but talk in the market later had it PCCW was contemplating a $1 billion issue instead.
Concern that Argentina's government might have to restructure its debt has hammered the emerging markets this month, and weak economic releases have come out of Asia. PCCW's deal also faced pressure from a recent surge in new supply of high-grade Asian bonds and negative sentiment related to PCCW's depressed share price.
-- Steven Vames, John Dooley and Sonja Ryst
Write to Andrew Gelfand at andrew.gelfand@dowjones.com2 and Michael S. Derby at michael.derby@dowjones.com3
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