5:00 PM EDT :
Treasuries rose today as developments in the stock market went from bad to worse in afternoon trading action. Late in their sessions, the 10-Year Treasury Note was up by 20/32, lowering its yield to 4.68%; the Dow was down by 281.91 points to 13,181.91; and the Nasdaq was down by 64.73 points to 2,511.25.
Most of the major market influences were aligned to support bonds today. The employment report, typically a powerful market-mover, came in weaker than expected with fewer job gains than predicted in July and the highest unemployment rate in six months.
And the ISM Services Index took a larger than expected fall in July. While still indicating an expansion of activity, the reading was the weakest since March. The news brought the stock market's two day rally to a halt, thereby making Treasuries that much more appealing.
News that American Home Mortgage was slashing its operations and a downgrade of Bear Stearns by Standard and Poor's raised credit concerns -- giving a boost to government debt and placing additional pressure on stocks. Stocks did not even get a lift from a sharp downturn in oil futures. A barrel of light, sweet crude oil for next month delivery fell by $1.76 on the New York Mercantile Exchange to settle at $75.10. The decline was the largest for a front-month contract since June 8. Last Tuesday, the closing price was a record high $78.21.
By the end of stock trading, the Dow had lost 2.09% on the day; the S&P 500, 2.66%; and the Nasdaq, 2.51%. Since July 19, when the Dow closed at its record high of 14,000.41, the index has lost 5.9%. The Dow's close today was the lowest since May 1, the Nasdaq's since April 19, and the S&P 500's since April 2. Thanks to gains on Monday, Wednesday, and yesterday, the Dow only lost 0.63% for the week; the S&P 500, 1.77%; and the Nasdaq, 1.99%.
In contrast, the yield of the benchmark 10-Year Note fell this week by 8 basis points, a fourth consecutive weekly decline totaling 50 basis points (yield moves inversely to price). Today's closing yield was the lowest since May 11.
Next week, the economic release calendar is relatively light, but new Treasury supply will be coming to market and the Federal Reserve's Open Market Committee (FOMC), the monetary policy arm of the central bank, will be holding a policy meeting.
There are no major market influences scheduled for Monday. On Tuesday, the Labor Department will release its preliminary report on productivity for the second quarter. The final report for the first quarter said that productivity (output per nonfarm business worker per hour) rose by 1.0% following a 2.1% increase in the fourth quarter of last year. The deceleration reflects the slowdown in the general economy as indicated by the gross domestic product (GDP) which rose by 0.7% in the first quarter following a 2.5% increase in the fourth quarter.
The initial report on the seasonally adjusted, annualized level of GDP for the second quarter indicated a 3.4% increase from the level in the first quarter. Consequently, analysts are looking for a stronger productivity reading. Current predictions run between 2.0% and 2.4%.
Increased productivity is usually a positive influence on the markets. The increased output per hour is seen by stock traders as a bullish economic development; more efficiency and therefore better earnings. And the efficiency often translates into reduced labor costs per unit of output which has a salutary effect on inflation pressures -- a plus for both stocks and bonds. However, the relationship between output and labor costs is not always so simple. While productivity growth decelerated in the first quarter, unit labor costs rose by only 1.8% following a surge in the fourth quarter of 8.9%. For the second quarter costs are expected to have increased by between 1.5% and 2.0%.
But the main event of the day will be the release of the FOMC's latest statement on monetary policy. Between June of 2004 and June of last year, the FOMC hiked short-term interest rates seventeen times in quarter-percent increments from a forty-six year low of 1.00% to 5.25%. Since then, the committee has made no further rate changes but its position has been that inflation risks remain dominant.
Earlier this year, Fed watchers had expected a rate cut before too long since the economy seemed to be faltering. But the initial report on second quarter gross domestic product indicated a 3.4% growth rate following just a 0.6% increase in the first. Moreover, the Fed has not provided any discernable signal that it intends to change its current policy stance.
In his appearances last month before the House Financial Services Committee and the Senate Banking Committee, Fed chief Ben Bernanke said that although core prices (ex-food and energy) for personal consumption expenditures had moderated somewhat in the previous couple of months, the data could reflect transitory conditions and that increased resource utilization and a spill-over of high energy prices into other areas could lead to higher levels of inflation.
This echoed the last few policy statements, the last of which expressed the sentiment this way, "Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures."
No rate change is anticipated on Tuesday but the policy statement has the potential to move the markets as any perceived shift in position could cause a sharp response. Of particular interest will be the amount of emphasis the statement puts on the weak housing and subprime mortgage finance situations. Mr. Bernanke devoted a great deal of time on the matter in his congressional testimony. But even if there is nothing new in the statement, this could weigh on the markets as it would be interpreted as a confirmation that no change is forthcoming in the months ahead.
The statement is usually issued at around 2:15 PM Eastern Time. The uncertainties associated with the release will keep traders in a defensive posture in the morning and the response to the statement will color market action in the afternoon.
On Wednesday, the report on wholesale inventories for June will be released. In the last report, the Commerce Department said the seasonally adjusted level of wholesale inventories rose by 0.5% in May. The increase, the largest in four months, was stronger than the 0.3% or 0.4% that analysts had predicted. But, as expected, sales were also strong -- up by 1.3%. This left the inventory-to-sales (I/S) ratio at a record low 1.11.
The (I/S) ratio is the value of supplies on hand, divided by the value of sales for the month. The result is how many months it would take at the prevailing sales pace to entirely deplete the existing inventory. The low ratio means that pressure to replenish supplies is high -- a bullish economic indicator.
For June, inventories are expected to have risen by about 0.4%, a sixth increase in as many months. The I/S ratio is expected to remain low.
Wednesday also brings a couple of minor releases. The Mortgage Bankers Association will release its report on mortgage application activity for this week and the Energy Department will release its weekly report on oil inventories.
New first new supply (other than the weekly issuance of Treasury Bills -- securities with a maturity smaller than a year) comes on Wednesday as the Treasury will be auctioning a new issue of 10-Year Notes. On the current issuance schedule, there is an initial issue each quarter that is followed a month later with a sale of an additional amount of the initial issue.
The arrival of new supply usually keeps bond prices down until the market has a chance to begin digesting the inventory. Traders who will be making bids refrain from pushing prices up prior to an auction in order to keep yields up (bids are for yield -- the higher, the better for the auction participants). Other traders also avoid purchasing the soon-to-be off-the-run issue since the new one will have greater liquidity. They also assume a wait-and-see posture until the results of the sale are known.
The last initial offering in May produced mixed results. Bids exceeded the $13 billion offer amount by 2.30 to 1, down from February's bid-to-cover ratio of 2.41 and the 2.39 average for the last twelve initial offerings prior to May's. Noncompetitive bids, a gauge of individual investor demand, totaled $61 million, up slightly from February's $57 million but down from the twelve-auction average of $95 million.
But foreign demand was decent. Indirect competitive bids, which include those from foreign central banks, garnered 44.1% of the issue. This award portion was up from the 29.2% in February's auction and the twelve-auction average of 38.5%.
Wednesday's issue will also have a face value of $13 billion, matching the size of the previous eight initial offerings. The deadline for competitive bids is 1:00 Eastern Time.
On Thursday, the jobless claims report comes out. In yesterday's report, the Labor Department said the seasonally adjusted level of initial claims for state unemployment benefits rose last week by 4,000 to 307,000. The previous week's originally reported level of 301,000 was revised up by 2,000 to 303,000. But the four-week moving average, which smoothes out some of the short-term volatility, fell by 3,500 to 305,500, its lowest reading in nine weeks. The average weekly reading for the year to date is 317,200.
The report said that continuing claims for the week ending July 21 (continuing claims must be at least a week old) fell by 16,000 to 2.525 million, the lowest level in five weeks. The four-week average declined by 9,250 to 2.545 million. The average weekly level of continuing claims for the year to date is 2,520,345. Although the latest reading is in line with this year's average so far, it is slightly elevated from the average reading in 2006 of 2,458,519.
Despite last week's increase the initial claims level suggests that hiring continues to outpace layoffs, which translates into net payroll growth.
More supply will be hitting the market on Thursday as the Treasury will be auctioning $9 billion in 30-Year Bonds. The Treasury announcement said the bonds sold on Thursday will actually have a maturity of 29-years and 9-months. The issue does not appear to be a reopening, however, since May's issue was a reopening of February's 30-Year Bond and therefore had at time of sale a 29-year and 9-month maturity. Thursday's issue also does not have the same identification code as May's and February's.
February's auction had mixed results. The bid-to-cover ratio on the $9 billion offering was 2.46, the highest of the three auctions in the current issue cycle (issuance had been discontinued in 2001 and reinstated last year). But non-competitive bids totaled just $9 million, the lowest amount in the current issue cycle up to that time. Indirect competitive bids received a relatively healthy 42.0% of the issue.
Last May's reopening auction was weak. The bid-to-cover ratio for the $5 billion offering was 1.97, non-competitive bids totaled just $2.5 million, and indirect competitive bids garnered only 10.4% of the issue.
On Friday, the report on import and export prices for July will be released. In June, the index of import prices rose by 1.0% following a 1.1% rise in May. A couple of details offset the effect of the inflation concerns roused by the recent increases. For one thing, following a ten-month high jump of 1.6% in March, the increases got progressively smaller in the following three months. Most importantly, excluding the volatile category of petroleum products (imported oil), prices rose by just 0.2% in June -- the smallest increase since February's flat reading (0.0%). Petroleum product prices rose by 4.7% in June.
Export prices showed little movement. Overall prices rose by 0.3% in June after a 0.2% rise in May. Excluding the large but volatile category of agricultural products, prices were up by only 0.1% following a 0.2% rise in May.
The final scheduled new item of the week comes out on Friday afternoon. At 2:00 PM Eastern Time, the Treasury will release its budget figures for last month. In July of last year, the value of government outlays exceeded receipts by $33.2 billion. A slightly smaller deficit of about $32.5 billion is predicted for last month.
This would bring the running total for the fiscal year to date (begun last October) to a deficit of $153.5 billion. While still a sizeable gap, it compares favorably to the $239.6 billion shortfall for the same period in the 2006 fiscal year. In fact, the total to date would be the smallest deficit for the same period since 2002 when it was $145.5 billion. The improved budget picture is a plus for Treasuries since it means less will have to be issued in the future to fund government operations and pay the debt on previously issued securities.
10:30 AM EDT :
The news of the day has been uniformly favorable for Treasuries; that is, more bearish than anticipated. Weak economic news reduces pressure on the Federal Reserve to keep a hawkish stance on interest rates. Currently, Treasuries are firmly ahead while the stock indices have declined sharply.
In the major economic release of the day, the employment report indicated that job growth was weaker than analysts had predicted. The Labor Department said that the seasonally adjusted level of nonfarm payrolls rose by 92,000 last month and June's originally reported rise of 132,000 was revised down by 6,000 to 126,000.
In the goods producing sector, construction payrolls fell by 12,000 and manufacturing payrolls were down by 2,000 (a thirteenth consecutive monthly decline). In the services sector, the category of education and health saw the biggest increase with a gain of 39,000, the thirty-fourth consecutive increase. In the category of financial activities, payrolls gained 27,000 jobs and in the category of professional and business services they were up by 26,000. Payrolls in retail sales fall by 1,200. A surprise was a 28,000 drop in government payrolls, the first decline in eighteen months.
The report said that the unemployment rate, the portion of the active workforce without jobs, edged up to 4.6% in July from June's rate of 4.5%. The increase was the first since April and the rate was the highest since January. Nevertheless, it is still considered low by historical standards. The average monthly reading so far this year has been 4.5%. This compares favorably with last year's average of 4.6% and 2005's average of 5.1%.
An item that was mildly positive for both stocks and bonds was a slight decline in the growth rate of average hourly wages. They grew by about 0.35% in July after two month's of 0.40% growth.
The last major economic release of the week was also bond-friendly. The Institute for Supply Management said today that its index on the services sector came in at 55.8 for July. Any reading over 50.0 indicates a general expansion of activity relative to the preceding month and July's index represented a fifty-second consecutive monthly expansion. As expected, the reading was down from June's fourteen-month high of 60.7. But the drop was the largest since September of 2005 and the reading fell short of the 59.0 to 59.5 that forecasters had predicted.
Though the services index usually does not have the same market influence as the manufacturing (the services data series is relatively young and the sector is so broad that varying categories tend to cancel each other out), the effect of today's report may be getting additional clout from the fact that the manufacturing index forlast month was also weaker than expected.
Another piece of news this morning is also making government-backed debt securities more attractive in comparison with other forms of debt securities. The issue of problems in the housing sector disrupting the financial market was underscored by the announcement from American Home Mortgage Investment Corp. that it was terminating most of its operations and employees. Earlier this week, the lender said it was having trouble repaying bank loans which
had been used to fund mortgage loans.
