Interest Rate Commentary
Thursday: 01/29/04 5:00 PM EST: Treasuries are lower this morning, extending yesterday’s losses while stocks, though mixed atpresent, are also trending down in early action. In addition to the intensified concern — stemming from yesterday’s Fed announcement — that interest rates may be raised sooner than previously thought, bonds are under pressure from positioning for today’s 2-Year Note auction. The economic news of the day has been largely overlooked.
The economic data released this morning had little market impact. The level of initial jobless claims declined slightly last week and the rise in employment costs slowed more than expected in the fourth quarter of last year.
Positioning for the month’s 2-Year Note auction may have added additional weight on the bond market this morning, which was continuing its fall in response to yesterday’s Fed meeting statement, which failed to contain the reassurance that the committee’s accommodative policy could be retained “for a considerable period.”
Today’s auction was met with tepid demand. Bids exceeded the offer amount by 1.87 to 1, a lower bid-to-cover ratio than the 2.15 posted in December’s auction. But some analysts were encouraged by the fact that indirect competitive bids, which include foreign accounts, were awarded about 42% of the $26billion issue in contrast to December’s 29% for an issue of the same size. Foreign buying has been cited as a major contributor to the price gains seen earlier in the month.
In regards to yesterday’s wording change by the Federal Reserve, today’s release of the minutes from December’s meeting included the following paragraph:
“Views differed with regard to the reference in recent statements to maintaining an accommodative monetary policy “for a considerable period.” A number of members argued that its deletion would serve to enhance the Committee’s flexibility to adjust monetary policy at a later date when that was deemed appropriate on the basis of evolving economic circumstances. A majority, however, preferred to retain the phrase, at least for now. They noted that the changes in their assessment of risk [asserting that “the probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation”] would convey the evolving views of the Committee and they believed the “considerable period” reference still accurately conveyed the Committee’s policy intentions. Given the decision to retain the reference in question, all the members saw merit in associating it more clearly with economic conditions, specifically the persistence of quite low inflation and slack in resource use, as opposed to having it appear to be linked only to the passage of time.”
After yesterday and this morning’s bond losses, some buyers were lured into the market this afternoon by the lower prices. Some bargain hunting may also account for the lack of follow-through on yesterday’s run-offing the stock market. Blue chips found additional support from a couple of bullish corporate earnings releases but the tech sector continued to lose ground. By the end of the session, the Dow was up by 0.40%and the S&P 500 by 0.50%. The tech-heavy NASDAQ slipped by 0.44% on the day but this was an improvement from its session low when it was down by 1.75%.
Tomorrow, the main event will be the release of the advance estimate of gross domestic product for the fourth quarter of last year. The latest consensus forecast is for an annualized growth rate of 4.8%, down from an 8.2% rate in the third quarter, but still solidly bullish. GDP is the dollar value of all final goods and services produced by labor or property in the country in a year. Quarterly data is seasonally adjusted and annualized and the percent changes from quarter to quarter indicate the speed and direction of economic activity.
Tomorrow also brings the final read on the University of Michigan’s Consumer Sentiment Index for the month. The release is expected to confirm the preliminary surge in optimism reflected in a reading of 103.2 versus December’s final reading of 92.6. The initial January reading was the highest since November of 2000.
The final release tomorrow is the Chicago Purchasing Managers Index, a gauge of manufacturing activity in this highly industrialized region and an important clue as to what Monday’s index on the national sector will look like. The Chicago PHI hit a nine-year high of 64.1 in November then fell slightly in December to59.2 (a reading above 50.0 indicates expansion relative to the preceding month). Forecasters are predicting reading of 61.5 or 62.0 for January 10:30 AM EST : Treasuries are lower this morning, extending yesterday’s losses while stocks, though mixed at present, are also trending down in early action. In addition to the intensified concern — stemming from yesterday’s Fed announcement — that interest rates may be raised sooner than previously thought, bonds are under pressure from positioning for today’s 2-Year Note auction. The economic news of the day has been largely overlooked.
The Labor Department reported that the seasonally adjusted level of initial claims for state unemployment benefits fell by 1,000 last week to 342,000 from 343,000 in the previous week (originally reported as341,000). The four-week moving average, which smoothes out some of the short-term volatility, rose slightly(750) to 346,000 from 345,250. Despite the increase, this was still the second lowest four-week reading in three years. The claims news came as no surprise as the downward trend has been evident since last April.
The news release said that continuing claims for the week of January 17 (continuing claims must be at least week old) also rose, but only by 11,000 to 3.131 million from 3.120 in the previous week. The level was the second lowest since August of 2001.
The Labor Department also reported this morning that its Employment Cost Index (EKE) for the fourth quarter of last year rose by 0.7% after a rise of 1.0% in the third quarter. Forecasts had called for a rise in the index of 0.9%. Increases moderated in the category of wages and salaries, up by 0.5% versus a gain of 0.7%in the third quarter. And in the category of employee benefits, costs increased by 1.2% versus a rise in the previous quarter of 1.5%.
The EKE figure represents a positive influence for both stocks and bonds. It indicates tame inflation emanating from the labor market and it therefore reduces the pressure on the Fed to raise interest rates. An added plus for the stock market is that in combination with rising productivity gains, mild increases unemployment costs suggest that corporate earnings will be strong.
Still to come, the Treasury will be auctioning $26 billion in new, 2-Year Notes today. With the recent, sudden increase in yield levels, the issue should be readily absorbed unless traders feel that the bond market will continue falling and push yields even higher . . . .