Bonds Drift Lower in Afternoon

Bond traders basically ignored this morning's spate of economic data.
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Gentlemen, stop your engines!

Trading activity in the bond market is certainly winding down for the year, but it wasn't unreasonable to expect at least a flurry of trading this morning on the release of the

industrial production

and

business inventories

reports.

But those reports produced barely a whimper and Treasuries faded away in the afternoon. Those who would have supported the market aren't taking risks at this time of the year, concentrating on preserving their gains. Lately the 30-year Treasury bond was down 13/32 to 97 7/32. The yield was 2 basis points higher at 6.33%.

The day's only other major news was the details of next week's two-year Treasury note auction. What's interesting about this $15 billion auction? Well, for one, the settlement date is Dec. 31, the last day of the year. (Settlement refers to the day the money changes hands. No, it's not in big canvas sacks with "$" signs on the bags.) Partially because of the proximity to the Y2K date change, so far, the market's interest in buying this is pretty darn low.

"This issue is going to be inhibited not only by year-end constraints that people might have with their balance sheets, but because there are shops that say, 'no more trades after Dec. 30. We want our back-office guys to be done,'" said David Ader, director of fixed income at

Thomson Global Markets

. "People have cash and they will want to keep it as cash."

But the complications don't stop there. The Treasury said today that this issue won't necessarily be a two-year note. If it is sold at a yield between 6.125% and 6.25% next Wednesday, it would be designated a reopening of five-year notes sold in December 1996, the department said.

Normally, an announced issue will trade, on a "when-issued" basis, at a lower yield than the most recently issued security of its type. Dealers are willing to pay a higher price, to receive lower yields for the newest notes, because they're the most liquid, or easily tradable.

But the yield on this impending note is actually higher than the current two-year note. The when-issued note was recently yielding 6.09%, while the current two-year note was yielding 6.08%. While Ader said the Dec. 31 date is part of the reason for the yield reversal, he also said it's because of the uncertainty as to whether this issue is going to be a new note or an old one.

That might have been the day's most interesting occurrence.

Maybe the bond market did enough selling yesterday to cover today, because the industrial production numbers certainly weren't friendly for bonds. Industrial production rose 0.3% in November, more evidence of increasing strength in the manufacturing sector. In addition, September and October's figures were revised higher.

Capacity utilization was unchanged at 81%, but that's only because October's utilization rate was revised up to 81% from the original 80.7% estimate. Economists were looking for a decrease in capacity utilization to 80.6%,

Reuters

said.

First Union's

chief capital markets economist David Orr pointed out in a comment that productivity growth must still be "exceptionally strong," because manufacturing employment and hours are falling, even while output has increased.

Business inventories rose 0.2% in October, while sales rose 0.5%. Massive stockpiling of inventories, which economists presumed would happen as a precaution against Y2K, hasn't happened yet. Either the business sector as a collective force isn't worried about Y2K, or sales are running at such a rapid pace that they are preventing businesses from filling the warehouses.