Bloomberg On Improving Mortgage Numbers

September 12, 2003

U.S. Treasury notes surged in New York trading, sending yields to their lowest since July, after retail sales rose less than forecast last month and a measure of consumer confidence unexpectedly declined.

Traders increased bets the Federal Reserve will keep its target interest rate at a 45-year low next year amid a hiring slump and low inflation. The benchmark 10-year note is headed to its fourth straight week of gains, the longest stretch since December, and the two-year note is having its best two-week period since July 2002.

``Any thought that growth was kicking off gangbusters and the Fed was going to be raising rates in the first quarter has pretty much been put to rest,'' said James Prusko, who helps manage $75 billion of fixed-income assets at Boston's Putnam Investments. ``There is still potential for rates to fall from here.''

The 4 1/4 percent Treasury note due in August 2013 rose 7/8, or $8.75 per $1,000 face amount, to 100 11/32 at 12:03 p.m. in New York, according to Zions Bank. Its yield fell 10 basis points, or 0.10 percentage point, to 4.21 percent. The yield fell as low as 4.17 percent, the lowest since July 25. The 2 percent note due in August 2005 rose almost 1/4 to 100 25/32, as its yield declined 10 basis points to 1.59 percent. The yield has fallen 37 basis points the past two weeks.

The 10-year note's yield may decline to 4 percent in the coming months, Prusko said. The note's gains accelerated after the yield dipped below 4.26 percent, its 50-day moving average.

Room to Cut

Sales increased 0.6 percent during the month, less than half as much as economists expected, to $319.2 billion, the Commerce Department said. The University of Michigan's consumer sentiment index fell to 88.2 for September from 89.3 in August. The median forecast was for a rise to 90.2.

The reports come a day after Labor Department figures showed the number of Americans filing for jobless benefits unexpectedly rose last week, to 422,000 from 419,000. Fed Governor Ben S. Bernanke said last week that policy makers have room to cut its target rate of 1 percent if the hiring slump continues.

``The Fed certainly isn't going to raise rates until they are certain the economy has fully rebounded and they are seeing signs of inflation,'' Joseph Shatz, a senior government bond strategist at Merrill Lynch & Co. in New York, one of the 22 primary U.S. government securities dealers that trade with the Federal Reserve Bank of New York. ``Today's report delays any possible hike until further out next year.''

U.S. stocks and the dollar fell as investors lowered their expectations for growth in the world's largest economy.

Rate Forecasts

The yield on the March Eurodollar futures contract, a gauge of three-month bank lending rates, fell 5.5 basis points to 1.28 percent, and is down from 1.56 percent at the start of last week. Benchmark three-month lending rates have averaged 24 basis points higher than the Fed's target over the past 10 years.

Central bank policy makers have cut their target rate 13 times since January 2001 to spur the economy and help prevent a slowdown in inflation. A falling inflation rate can hurt the economy by making it harder for companies to raise prices and profit margins, keeping them from hiring more workers.

Retail sales ``suggest a more moderate pace of growth,'' said Anthony Karydakis, senior financial economist in Chicago for Banc One Capital Markets Inc., another primary dealer. ``That's good for Treasuries because it tends to defer further out into the future the prospect for Fed tightening, and removes from the horizon the potential for a rise in inflation.''

Inflation remains subdued, a Labor Department report today showed. Excluding food and energy, prices paid at the wholesale level rose 0.1 percent in August, the department said. The rate of increase from a year earlier was 0.4 percent.

Fed Meeting

Fed policy makers next meet on interest rates Sept. 16. All 73 economists polled by Bloomberg News expect the Fed will leave the federal funds rate unchanged at 1 percent.

``The market is looking ahead to the upcoming Fed meeting where they will again tell us that monetary policy will remain accommodating for a long time,'' said Anthony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York. ``That's the root of the movement in the bond market of the past week.''

Economists have been boosting their forecasts for economic growth. The economy is likely to grow at a 4.5 percent rate in the current quarter, the most since the first three months of 2002, according to the median estimate of 59 economists surveyed from Aug. 28 through Tuesday. The forecast was almost a full percentage point higher than the median estimate a month earlier.

Yields declined even as the Treasury Department this week sold $16 billion of five-year notes and $13 billion of 10-year notes.

Boosting Sales

The government has boosted sales of Treasury notes to finance a widening federal budget deficit. The Congressional Budget Office last month forecast the deficit will reach $480 billion in the fiscal year that begins Oct. 1. The current year's deficit will be about $401 billion. The biggest deficit on record was $290 billion, in 1992.

``We have a lot of supply in the pipeline due to the deficits,'' Merrill's Shatz said.

The Treasury resumed monthly sales of five-year notes in August after five years in which the notes were sold quarterly, as budget surpluses reduced the government's financing needs. It began selling 10-year notes eight times a year, up from six in the late 1990s.

This week's auctions included the first September sale of five-year notes since 1997 and the first September sale of 10- year notes on record.