US Treasuries retreat, more Fed rate hikes expected

12 Jun, 2005

US Treasury debt prices retreated on Friday as investors concluded that the Federal Reserve would not stop raising interest rates soon. Traders said securities dealers also were cutting prices to help sell recently auctioned five- and 10-year Treasury notes. "We traded off at the end of last week and tried to rally this week, but it was the lack of follow through buying that really depressed us," said Dominic Konstam, interest-rate strategist at Credit Suisse First Boston.
Expectations that Federal Reserve Chairman Alan Greenspan's testimony before the Joint Economic Committee of Congress on Thursday might spur further buying - or even validate existing yields - were disappointed, analysts said.
"Greenspan didn't give you that warm fuzzy feeling that he was about to stop raising interest rates, so in general there's been some paring back," Konstam said.
Anthony Karydakis, chief US economist at J.P. Morgan Asset Management, said "second thoughts" about Fed Chairman Alan Greenspan's testimony on Thursday prompted a reversal.
The Fed has raised its federal funds rate that banks charge each other on overnight loans eight times since last June to 3.00 percent. Rate futures markets are now betting that the Fed will raise rates three more times this year to 3.75 percent.
"When people let Greenspan's testimony sink in overnight, they realised that it wasn't very positive material for bonds," Karydakis said. "It has hit the market that Greenspan didn't sound like someone who intended to pause after the June monetary policy meeting and that that was inconsistent with the levels we were at. At those levels, the market needed fresh impetus to provide it with more momentum and it didn't get it from Greenspan."
Stone and McCarthy Research Associates analyst John Canavan said dealers' need to distribute the new supply of five- and 10-year notes, rate-lock selling ahead of corporate supply scheduled to come to market next week, and the break in the 10-year note yield back above 4.00 percent were some of the reasons behind the position-squaring responsible for a lot of the market's "pretty sharp" decline.
Karydakis said it was too early to assess the staying power of the 10-year note yield's move back above 4.00 percent.
"We need another day or two to determine whether we're going into above-4.00 percent territory again," he said. "Clearly, the market tone has turned a little sour."
Still, analysts noted that the coming week was chock full of fresh data on important facets of the economy like retail sales, manufacturing, consumer sentiment and inflation.
"If we get a flat core inflation reading, people will say, 'This is it,'" Karydakis said. "But the levels we were at, with the 10-year note yield below 4.00 percent, were unsustainable without further validation from Greenspan and they absolutely did not get that so the response was to retreat."
Karydakis said the economic numbers due in next week could provide a lot of opportunities for bond market price action.
The US Department of Commerce said the April gap came in at $56.96 billion, narrower than economists' forecasts of $58 billion. The March trade gap was revised down to $53.56 billion from the $54.99 billion initially reported, further supporting the view that the report portended well on growth.
The break above 4.00 percent in 10-year note yields led to additional selling, said Gemma Wright, director of market strategy at Barclays Capital.
Some traders said unwinding of positions by players in the mortgage securities market also helped to fuel the move.
In late trade, the 10-year note was down 24/32, its yield having risen to 4.05 percent from 3.95 percent on Thursday.
Two-year notes slipped 4/32, their yields rising to 3.70 percent from 3.62 percent late Thursday.
Five-year notes fell 13/32, their yields rising to 3.84 percent from 3.74 percent on Thursday.
The 30-year bond slid 1-15/32 lower, its yield rising to 4.32 percent from 4.23 percent on Thursday.

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