5:00 PM EST: Treasuries rose sharply again today but they had risen enough by the time the Fed made
its policy announcement this afternoon that the reaction following the Fed move was
muted. After making gains earlier, stocks initially spiked higher but then declined,
sending the Nasdaq index into negative territory.
In late trading, the 30-Year Treasury Bond was up 1 point (32/32), lowering its yield
to 5.53%; the 10-Year Note was up 19/32, lowering its yield to 5.15%; the Dow was up
6.16 points to 10,887.36 and the Nasdaq was down 65.46 points to 2,772.89.
As expected, the Federal Open Market Committee, the monetary policy body of the Federal
Reserve, decided today to cut the fed funds target rate from 6.00% to 5.50%. The fed
funds rate is the interest rate banks charge each other for overnight borrowings. The
rate is used as a benchmark by which other rates are set. A number of banks quickly
reduced their prime rate following the Fed rate cut. The prime rate is the interest
rate banks charge to their best commercial customers.
The Fed also cut the discount rate from 5.50% to 5.00%. The discount rate is the rate
charged to banks for loans from the Federal Reserve. It has less influence on the
general interest rate environment than the fed funds rate but the cut adds emphasis to
the Fed's move. Also adding emphasis is the fact that the Fed has now moved a whole
percentage point within one month -- the first time this large a move has been made
since 1984.
The announcement accompanying the end of its meeting indicated that weakness was the
greatest risk facing the economy, suggesting that the committee is inclined to make
further steps to address the risk.
But following on a string of economic indicators showing a significant slowdown in the
economy, the Fed move came as no surprise. Just yesterday, the report on consumer
confidence showed the steepest drop to its index reading in over ten years. This
morning the first look at gross domestic product for last quarter revealed the
smallest growth rate in almost six years. Today's release of the Chicago Purchasing
Managers Index revealed a decline to a level not seen since 1982.
The only anomaly of late was this morning's report on new home sales for December. It
showed a suspiciously large increase in sales pace for the month. But the report did
not hold back Treasuries prices which built on yesterday's healthy gains.
Adding to the lift in the bond market was the announcement by the Treasury this
morning that another $9 billion in previously issued securities would be repurchased
in the second quarter. The government has been reducing its debt by issuing fewer
securities and by buying back some of its old issues. Because of their increasing
scarcity, those Treasuries still in circulation are also increasing in value. The
announcement this morning also included the news that the 1-Year Bill will no longer
be offered after February. And many economists are questioning the need for more
30-Year Bond offerings if the debt is to be eliminated in the next ten years.
Stock traders were less enthusiastic about the continuing downturn in the economy and
the initial bump on the Fed move announcement was quickly met with a round of profit
taking. The gains made in the Nasdaq during the month may have sapped its forward
momentum for now. After being up by as much as 1.20%, the index fell for a 2.31% loss
on the day. The Dow fared better but pulled back from a 0.70% gain for a meager 0.06%
advance. The S&P 500 declined 0.57%.
Tomorrow the market will continue the adjustment to the new rate environment.
Treasuries may be vulnerable to some profit taking following their recent climb. In
two days, the price of the 10-Year Note has risen almost 1.25% while the 30-Year Bond
has risen almost 2.50%.
The economic news of the day is expected to be bond-friendly though it may already
have been priced into the market. Recent lay-off announcements are expected to keep
the initial jobless claims level on an upward path.
The National Association of Purchasing Managers Index is expected to show more
weakness in the manufacturing sector. This would come as no surprise because of the
softness in the Philadelphia and Chicago regional reports.
Personal income and spending changes for December will be reported tomorrow. The
current estimates here are from flat to a slight increase in both categories. And
the report on construction spending for December is also due out tomorrow morning. A
0.5% decline is anticipated.
Other market influences tomorrow include the release of the Fed's December meeting
minutes. And there may be some positioning in the afternoon in front of Friday's
release of the monthly employment report.
10:30 AM EST: Treasuries are sharply higher this morning in anticipation of this afternoon's Fed
announcement. Stocks are also up in early trading.
The Commerce Department reported this morning that the first official estimate of 4th
quarter gross domestic product (GDP) revealed a 1.4% annualized growth rate. This was
lower than the analysts' forecasts of a 2.3% rate for the quarter and down from a 2.2%
rate in the 3rd quarter. The chain-weighted price deflator, a measure of inflation,
came in at 2.1% as expected -- up from a 1.6% reading in the 3rd quarter. In contrast,
the 3rd quarter GDP reading in 1999 was 5.7% and for the 4th quarter it was 8.3%.
Estimates of the current growth level for the economy range from 1.0% to somewhere below
zero.
Today's report was just the initial snapshot of how the economy did in the 4th quarter
and is known as the advance report. As more data is compiled the GDP will be revised.
Next month the preliminary report will be released and in April the final report will be
issued.
The gross domestic product measures the market value of all final goods and services
produced in the country and offers the broadest perspective on the economy.
Today's report showed that there was a sharp 4.7% decline in capital expenditures for
equipment and software which has disturbing implications for subsequent productivity
growth.
The Chicago Purchasing Managers Index was weaker than expected for the month, falling to
40.2% from 45.2%. Estimates were for a 43.0% reading. In conjunction with the
Philadelphia report released on the 18th which was also much weaker than anticipated, today's
report leads one to conclude that tomorrow's national report will post a sixth
straight month of a sub-50% index, meaning that the vital manufacturing sector
of the economy continues to contract.
But the markets were surprised this morning by the news that new home sales in December,
which were expected to decline by about 1.5%, rose a remarkable 13.4% to a seasonally
adjusted annualized rate of 975,000. November's figure was revised downward from
909,000 to 860,000 but even if the rate had not been changed, December's report would
have shown a 7.3% spike. Of note in the report: sales in the West rose 38% and in the
Midwest by 22%.
Analysts felt that the declining consumer confidence would have more than offset the
fact that mortgage rates are so low. The magnitude of change in today's report leads
some to think that faulty seasonal adjustments may have distorted the figures.
In other news, the Treasury reported that next week's refunding auctions will total $32
billion; $11 billion in 5-Year Notes on Tuesday, $11 billion in 10-Year Notes on
Wednesday, and $10 billion in 30-Year Bonds on Thursday. The Treasury also noted that
it was eliminating the 1-Year Bill after February's issue. And the announcement also
stated that up to $9 billion in previously issued Treasuries would be repurchased in the
second quarter. This matches the $9 billion in the first quarter. Last year, the
Treasury bought back $30 billion in off the run government securities.
Also lending support to Treasuries was the announcement yesterday by the Congressional
Budget Office that the latest projections for the federal surplus is $3.12 trillion over
the next ten years. This is nearly $1 trillion higher than the $2.17 trillion the
office estimated last July. This eases some of the anxiety traders had over the possibility
that proposed tax cuts would crowd out the government's debt reduction efforts.
And finally, Treasuries are being supported by the fact that this is the last day of the
month when fund managers make last minute adjustments to their portfolios. This usually
entails purchasing government securities.
At 2:15 Eastern Time, the announcement by the Fed will be made. If the expected
half-point cut is announced, the market reaction may not be as volatile as the one on
the 3rd, however, a subdued reaction is by no means assured. With the recent rumors of
an even deeper cut, a half point reduction might actually disappoint some. A
three-quarter cut would provide a significant boost to the both stocks and bonds. A cut
of less than a half point would probably send both markets sharply lower . . . .
