PORTFOLIOS MGRS SEE MORE US TSY MKT DECAY DESPITE LESS SUPPLY
By Brendan Murphy
NEW YORK (MktNews) - Treasury Department issuance cutbacks and buyback proposals brought relief to the bond market just as the summer heatwave relented, but fixed-income portfolio managers nevertheless expect to sweat it out for the rest of the summer, perhaps for the balance of 1999 as the fundamental-technical high-pressure front moves through.
What some see as an incipient cooling in U.S. economic activity remains to be confirmed, not least through the July employment report coming out at the end of this week, particularly in the jobless rate and earnings components that reflect labor market conditions and consumer purchasing power. Meantime, rising anxiousness on the part of corporate treasurers to meet funding requirements before markets tighten further on fundamentals or in anticipation of year-2000 computer glitches looks to keep pressuring bonds with heavy new issuance.
Today alone, the market faces pricing of $5.5 billion in Walmart 2s, 5s, and 10s, $1 billion in Petronas 5s and 10s, a $2 billion FHLMC reopen and $2 billion in FHLMC 2009 notes.
"The market is technically oversold, as oversold as I've seen in 19 years that I can recall," remarked portfolio manager Michael Mullaney of Boston Partners Asset Management. But, "I don't see any dramatic reason for anybody to get in front of a train right now." He's heard talk of the 6.25% 30-year yield level as likely to pull investors off the sidelines. But "it may have to go higher than that for people to get interested," though real yields offer value here
Mullaney sees mixed signals in economic data, with activity slowing slightly to a probable 2.5%-3% pace, but hints of inflationary pressures discomfiting investors. The pickup in Asia and Europe, "a little bit of global warming" represents another hazard, he observed.
"Where are we seeing a slowdown in the economy?" demanded Treasury bond manager Alan Day of the Stratevest Group in Burlington, Vt. Rising mortgage rates have taken some of the froth off of the housing industry, "but we still have a lot of construction and commitments in the pipeline, so that's still going to be fairly robust. Auto sales are expected to hold up.
Even the latest announcements from the U.S. Treasury about the elimination of the 30-year tranche of this month's quarterly refunding and the possibility that budget surpluses will be used to buy back U.S. government debt could end up tweaking growth by giving longer-term yields a downward nudge, Day suggested. As it is, Day sees benchmark long rates holding in a 6%-6.25% range with "not enough of a movement to seriously impair the economy."
That probably means the Federal Reserve Board will be obliged to keep ratcheting up funds to unwind the rest of its 75 basis point easing move in late 1998 as a precautionary measure against inflation, and perhaps to maintain the dollar's value as the euro and yen rebound.
But reduced federal bond issuance should help keep the long end from overreacting to Fed moves, Day added. "I don't think we're going to see a huge steepening of the curve because we have this huge surplus being built up ... it's nice to have money in the bank," he added. With positive and negative forces in a stalemate, he's keeping duration "pretty neutral."
Treasury market sentiment is likely to be dominated in the near term by the July jobs report and anticipation of possible Fed tightening action on Aug. 24, said portfolio manager Richard Schwartz at New York Life Asset Management in Parsippany, N.J. Though there are "clearly some signs the economy is slowing ... we can't ignore the tight labor market," Schwartz said.
Rising concern late this year about the year 2000 date change should eventually boost bond prices, said "Investors are going to become risk averse" as the millennium approaches and boost allocations to bonds, he said. Treasuries could also gain on a dollar rebound.
For the moment, though, despite the bounce in long bonds at midweek, Schwartz expects to see a continuation of the widening trend in corporate and mortgage-backed spreads. "In the next month or two it's likely that corporate treasurers will remain heavy borrowers, and as the supply continues, spreads are likely to widen for technical reasons," he predicted. So he is keeping portfolio duration "fairly flat" with reduced exposure to all spread product.
"As year-end approaches, uncertainty levels in our opinion are going to increase," he added. "As uncertainty increases, that argues toward higher spreads." Thus, "the bond market has more downside than upside in spread product," though Treasuries should benefit in time.
Mullaney described a "sloppy market at best when it comes to credit spreads," citing factors like a swaps market imbalance in demand for fixed- and floating-rate deals, the former much in oversupply, relatively rich of on-the-run Treasuries, and a relatively flat yield curve that "forces people back down towards the shorter end ... and toward the floaters," he said.
Against this backdrop there's a "dearth of demand in the marketplace for bonds in general," with investment banks drawing down inventories, particularly in mortgage-backeds, while the mortgage banks themselves are net sellers, and bond mutual fund flows are off.
"People are just not that interested in the asset class" and corporate issuance weighs heavily with "a ton of supply getting through a relatively narrow door now," Mullaney said. Issuance is likely to slow down by the fourth quarter, but demand won't rebound until early 2000.
Like other managers, he is running bond portfolios neutral relative to their duration targets, but confessed to being overweight in spread product, "which has been painful" although he's prepared to wait for reversion to the mean to take place. "We don't love the last two months' performance, but eventually you will get that performance so long as you have the patience to hold the position," Mullaney said. "You don't know that with a duration play."
ANOTHER SIGN THAT INFLATION HAS BOTTOMED;
US TSY TO SELL 30YR TIPS IN OCTOBER INSTEAD OF 10YR
By Nikolai von Goihmann
WASHINGTON (MktNews) - In a revised schedule of offerings issued late Wednesday, the Treasury Department said the inflation-indexed security to be auctioned in October will be a 30-year bond, and not a 10-year note.
The indexed bond is set to be announced September 29 and will be auctioned on October 6 with settlement on October 15. |
