News of unexpectedly tame inflation in July boosted prices of long-term Treasury securities Friday, but the report failed to change the prevailing view that the Federal Reserve will hike interest rates next week.
Reflecting the still pervasive sentiment, shorter-term maturities - which stand to suffer the most from higher rates - posted only minor gains. Indeed, the inflation news only further muddled the market debate over when and by how much the central bank will next push up rates.By day's end, the price of the Treasury's 301/4-year bond was up 5/8 point, or $6.25 per $1,000 in face value. Its yield, which moves in the opposite direction, fell to 7.50 percent from 7.56 percent at the Treasury auction Thursday.
Prices of short-term Treasuries, meanwhile, rose only 1-16 to 5-32 point and intermediate maturities rose 1/4 point to 15-32 point, the Telerate Inc. financial information service reported.
Still, the modest rally in long-term bonds erased nearly all the sharp price drop from Thursday, when the market tanked following a lackluster auction of new 301/4-year bonds and a report of higher-than-expected producer inflation.
Many traders had prepared for a sharper increase in the wake of Thursday's report that producer prices jumped 0.5 percent in July. Bond market participants fear inflation because it tends to diminish the value of Treasury securities and other fixed-income investments. Inflation also increases the likelihood that the Federal Reserve will raise interest rates.
But on Friday, Labor Department reported that inflation as measured by the Consumer Price Index, excluding the volatile food and energy sectors, rose 0.2 percent in July, less than expectations of a 0.3 percent increase.
"The market was looking for a little bit worse numbers on the CPI," said Dana Johnson, chief analyst for First Chicago Capital Markets. "There's really no sign of accelerating inflation at the consumer level. That comes as a bit of a relief."
Market analysts traced most of the resulting spike in bond prices to a reversal of speculative positions established ahead of the consumer inflation statistics.
Prior to Friday's figures, traders anticipating higher inflation had borrowed bonds and immediately sold them on the hope that market prices would decline.
But when the report showed tamer-than-expected inflation and pushed bond prices higher, these traders were forced to cut their losses by snapping up bonds to pay off their loans.
Matthew Alexy, a market strategist at CS First Boston Corp., said the inflation data had not influenced his prediction that the Fed will push up its target for the federal funds by one-half percentage point to 4.75 percent.
Other market participants expect the Fed to push the rate up by one-quarter percentage point when its policymaking committee meets on Tuesday to set monetary policy.
"The CPI creates a backdrop where the move will be viewed as more of an insurance policy against an inflation spiral than some type of panicked attempt," Alexy said.
Since February, the Fed has raised its target for the rate that banks charge each other for overnight loans four times in a bid to keep inflation from getting out of hand. It also has raised the discount rate it charges member banks a half percentage point, to 3.5 percent.
The federal funds rate was quoted at 41/4 percent late Friday, unchanged from late Thursday.
The Lehman Brothers Daily Treasury Bond Index, reflecting price movements on bonds with maturities of a year or longer, rose 2.42 to 1,211.11.
Yields on three-month Treasury bills rose to 4.46 percent as the discount went up .02 percentage point to 4.36 percent. Six-month yields held at 5.09 percent as the discount was unchanged at 4.91 percent. One-year yields increased to 5.58 percent as the discount rose .01 point to 5.30 percent.
Yields are the interest bonds pay by maturity, while the discount is the interest at which they are sold.