All the Action Was Away from Equities

As major equity averages shuffled through a fairly uneventful session, the real action today was in fixed-income and currency markets, where Treasuries and the dollar suffered in tandem.

For now, it appears weakness in Treasuries and the greenback are coincidental, rather than one causing or contributing to the other. That explains why equities have largely been insulated from recent weakness in Treasuries and the dollar, and it should be welcome news for those who are concerned that stocks may be next on the chopping block.

Still, equity investors should take little comfort in what's happening in those "other" markets.

On the fixed-income front, the price of the benchmark 10-year Treasury fell 27/32, to 96 3/32, its yield rising to 5.39%, its highest level since July 5.

Treasury market participants reacted to a host of developments, including reports that former Federal Reserve governor Laurence Meyer told Goldman Sachs he expects the economy to grow by more than 3% in 2002.

Further heightening concerns about Fed rate hikes, the Commerce Department reported that business inventories rose 0.2% in January, the first increase in a year, compared with expectations for a 0.4% decline. Business sales rose 1.2%, suggesting companies are increasing production to meet rising demand.

Additionally, jobless claims fell 3,000, to 377,000, for the week ended March 9, a touch higher than expectations. But at 375,000, the four-week moving average remained below 400,000, where it has been all year.

The claims numbers have "stabilized completely" and indicate that last Friday's stronger-than-expected employment data "may not have been aberrational or technical or seasonal," said Kevin Flanagan, fixed-income strategist at Morgan Stanley Dean Witter. "Perhaps layoff activity has peaked. Moving forward, maybe the jobless rate doesn't go to 6.5%; maybe it topped at 5.8%."

Flanagan was less concerned about the inventory data, calling it "old news." But the claims numbers, plus the "weight of some increase supply" from corporate bond issuers such as General Electric(GE Quote), whose finance arm sold $11 billion of global bonds yesterday, are contributing to a "negative frame of mind" among bond traders, he said. "When you have days like yesterday where people buy [Treasuries], it is viewed as opportunity to book profits and get out."

On a more technical note, he said managers of mortgage-backed securities may be unloading longer-dated Treasuries to offset an extension in the duration of mortgage-backed securities, a reference to the so-called convexity trade.

Finally, Flanagan couldn't confirm rumors there was a large seller of two-year notes, where prices fell 8/32 and the yield rose to 3.59%, but he said "the footprint is there."

Notably, the fixed-income strategist said the bond market was not reacting to developments in the currency markets, where the dollar also weakened. "We had a little problem a week ago when the dollar broke some support areas, but I would not call it a currency play at this stage," Flanagan said.

That's good news, since the dollar foundered under the weight of a convergence of factors, falling 0.7% vs. the euro to 88.23 cents, its lowest level since Jan. 23. The dollar lost 1.2% vs. the Swiss franc, which traded at $1.6546 late in New York's trading session, its highest level in two months. Against the yen, the dollar slid to 129.24 yen from 129.50 late Wednesday.

The U.S. current account deficit fell to $417.4 billion vs. $444.7 billion for all of 2001, its first annual decline since 1995, the government reported today. But the deficit unexpectedly widened to $98.8 billion in fourth quarter, which spooked some investors a day after Fed Chairman Alan Greenspan warned about the need to restrain our reliance on foreign investment.

Additionally, Japan's government raised its forecast for economic activity for the first time since June 2000, while France reported stronger-than-expected industrial production data. Those reports, plus the Nikkei's latest rise of 1.3%, re-energized traders who believe foreign currencies and economies are starting to benefit from the economic recovery in the U.S., which they believe the dollar has already priced in.

As detailed last week, that mind-set partially explains the recent increased weightings to foreign markets that several Wall Street firms have made in recent weeks.

All that said, "the most important portfolio shift is due to the [Bush administration's] warmongering and fear the war may escalate into Iraq," said Marc Chandler, currency strategist at HSBC Capital Markets. "That is why the Swiss franc is the strongest currency" relative to the dollar today.

Responding to a question about Iraqi President Saddam Hussein, President Bush said "we are going to deal with him." That remark contributed to crude oil futures rising another 1.7% to $24.56 per barrel.

From the "Why Should We Care?" Department: Rising bond yields present an appealing alternative to equities to investors who may believe stocks are already overvalued. Secondly, a currency is a reflection of investors' belief in the strength of its underlying economy, which ultimately determines the fate of equities. The issue for U.S. equity investors is whether foreigners are growing weary of owning the dollar and dollar-denominated assets, which eventually -- ultimately -- would have a seriously negative effect on stocks.

Certainly that is a scenario the hardcore bears worry about (or is it wish for?).

HSBC's Chandler, conversely, suggested there's a "tenuous relationship" between currencies and equities, noting that foreigners primarily invest in U.S. fixed-income securities rather than equities. Furthermore, for all the volatility in recent weeks, the dollar is up slightly vs. the euro and down marginally vs. the yen year to date.

"Even if dollar trades broadly sideways, I don't think we're in for big collapse," he said. This may not be a rousing endorsement but it somehow feels uplifting on a day when myriad developments belied the equity markets' torpor.