NAPM, Fed Officials Bludgeon Bond Market
By David A. Gaffen Staff Reporter 6/1/99 4:42 PM ET
Bonds fell into a burning ring of fire today, and with each key economic release or speech from a Fed official, the flames rose even higher. By the time the carnage ended, the 30-year Treasury bond's yield had spiked by 10 basis points while the two-year note rose by 13 basis points. If, before today, the market needed any convincing that the Fed is going to hike interest rates come the end of June, it doesn't anymore.
The May Purchasing Managers' Index of manufacturing sentiment, released by the National Association of Purchasing Management, rose to its highest level since October 1997. Two normally dovish members of the Fed, Alice Rivlin and William McDonough, didn't offer any olive leaves today. Both said the economic risks had shifted toward inflation.
The July fed funds futures contract, used as a benchmark for what direction the market believes Fed policy will take, rose sharply today to yield 4.96% and is now factoring in an 84% chance of a rate hike by the end of June. The Federal Open Market Committee's next meeting is a two-day affair June 29 and 30.
The 30-year bond fell 1 6/32 to 90 19/32, as the yield closed at 5.93%. The two-year note closed down 4/32 to yield 5.53%. The difference in yield between the two fell to 39 basis points from 43 basis points Friday.
The NAPM's purchasing managers' index rose to 55.2. Until this point, the market was struggling, but this release was the blunt instrument to the bond market's skull. What disturbed the market more than the headline figure was the increases in two previously flagging components. The prices paid component eclipsed 50 for the first time since December 1997, rising to 52.2 from 49.9, while the employment series rose to 53.5 from 49.5, its first reading above that watermark since May of last year. The NAPM survey indicates expansion when it is greater than 50, contraction when it reads less than 50.
"There was nothing flukish about the PMI," said Jim Kochan, senior bond market strategist at Robert W. Baird. "The market is not misinterpreting the message here when it's translating this into an increased probability that the Fed is going to do something."
This report alone may not be enough to convince the Fed to raise rates, seeing as how it is a measure of sentiment rather than tangible figures, such as this Friday's May employment report. However, the uniform strength in today's release (eight of nine components read greater than 50) raises the possibility that manufacturing employment might rise for the first time since March 1998, excepting months affected by last year's strike at General Motors (GM:NYSE). Fed Chairman Alan Greenspan "had been falling back on the manufacturing sector to support his more dovish views," said Astrid Adolfson, financial economist at MCM Moneywatch. "Without that, he has to join in the camp of the more hawkish."
He may be joining his colleagues. New York Fed President McDonough said it would be wrong to assume that the huge rise in the April Consumer Price Index was a one-time event. He also added, somewhat ominously, that Fed members would "do what we have to do to maintain price stability." As McDonough is a less restrictive member of the Fed when it comes to monetary policy, this is a concern, because it means he may be convinced the time is right to raise interest rates.
"We're watching the more dovish people come out of the woodwork and hear them say things we haven't heard them say for a long time," Adolfson said.
Fed Vice Chairman Rivlin didn't sound quite as hawkish. Speaking at a financial conference in Montreal, she said the 0.7% increase in April CPI wasn't enough evidence to convince her of rising inflation. She said the balance of risks is shifting toward higher inflation, but her comments weren't as worrisome as McDonough's. Instead, she sounded somewhat satisfied that the Fed had adopted a bias toward tightening interest rates at the May 18 meeting.
"The Federal Reserve's Open Market Committee at its last meeting signaled its return to concern about overheating and the possibility of future inflation pressures," she said.
It might be that Rivlin is attempting to offset her more alarmist colleagues to avoid scaring the financial markets, but as she's the Fed member regarded as the most dovish, it's also possible that she'll be one of the last to come on board in supporting an interest rate hike.