Treasuries Take Another Step Back

Traders have plenty of time to contemplate a heavy new-issue calendar and what the Fed's neutral bias means.
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Treasury yields rose for the second day in a row, and for the same reasons: The new-issue calendar is heavy in the other bond markets, and European yields rose, forcing sellers of U.S. paper to mark down their prices in sympathy.

With no market-moving economic data on the calendar, the benchmark 30-year Treasury finished the day down 4/32 at 89 2/32, lifting its yield a basis point to 6.05%. Shorter-maturity note yields rose by roughly similar amounts.

With the economic data calendar sparse till next Wednesday, when the

Producer Price Index


retail sales

data for June will be released, the bond market is casting about for something to react to. Unfortunately, it's finding only reasons to retreat.

"I think it's mostly supply,"

Donaldson Lufkin & Jenrette

Treasury market strategist David Ging said, explaining the market's weakness this week. "You've got agencies coming, TIPS today, the


(F) - Get Report

deal and a whole slew of corporates expected in the next month, or two, or three."

Translation from trader-speak: Agencies are federal agency issues, and a big one was launched today.

Freddie Mac


started taking orders for a $3 billion five-year deal. TIPS are Treasury Inflation-Protected Securities, and $7 billion of the 10-year variety were auctioned this afternoon. Ford has a three-part deal that could be as large as $7.5 billion waiting in the wings. And loads of other corporations are waiting to tap the market once Ford gets out of the way with what could be the second-largest corporate issue ever.

In the immediate term, Ging said, a heavy new-issue calendar prompts selling of Treasuries as an underwriting hedge: If a rise in Treasury yields jeopardizes the deal, at least there's a profit on the short Treasury position. And in the longer term, "it soaks up all the bullishness from less Treasury supply," Ging said. Last week, a rally in Treasuries was aided by the announcement of a new, larger forecast for the size of the federal budget surplus. A surplus means a diminishing supply of Treasury securities (which finance deficits) boosting their value. "If the shrinking Treasury supply is going to be made up by increasing corporate supply, it mitigates the good Treasury surplus news," Ging said.

To a lesser degree, rising European bond yields are also putting pressure on Treasuries. "If global economies are recovering, it's not going to be good for Treasuries," Ging said.

But market mavens stressed that they're paying attention to the corporate slate and to Europe mostly because there's nothing else to do right now. Traders are waiting for next week's economic data, and to hear what



Alan Greenspan

has to say about it in his semiannual


congressional testimony, which today was slated for July 22 before the

House Banking Committee

. They're trying to determine whether the Fed will raise interest rates a second time when it holds its next meeting on Aug. 24.

"Ultimately, it's going to be a data story," said Tom Connor, head government bond trader at

J.P. Morgan

. "If it's strong, the market's going to be under pressure" regardless of the factors that are moving the market today.

Connor says this week's selloff is also due to reevaluation of what happened on the Fed front last week. When it raised the fed funds rate to 5% from 4.75% and shifted its official bias to neutral from tightening, the market rallied on the assumption that the bias shift meant the Fed wouldn't hike again in August, Connor said. This week, it's rethinking that assumption. As well it should, he says, considering that the Fed's habit has been to revert to neutral following a rate change, and a neutral bias hasn't prevented them from changing rates again at subsequent meetings.

"They've totally confused people," Connor said.

The confusion stems from the fact that the Fed only recently started announcing its bias. And from the fact that historically the bias has applied only to the period leading up to the next meeting.

The Fed has announced its bias twice now, and each time it has hinted that the bias applies more broadly to the future. That was the assumption the market made when it rallied last week. Now traders are wondering whether the bias still applies only to the intermeeting period, as it always has. "We don't know which definition of the bias is now employed,"

High Frequency Economics

chief U.S. economist Ian Shepherdson groused in a research note yesterday. "If the Fed doesn't know what it means, or what it is doing, how can the markets?"