Tue Jul 13, 2004
By Wayne Cole

NEW YORK (Reuters) - Treasury debt prices slid on Tuesday as a wave of speculative selling made a big splash in an otherwise illiquid market.

Traders said speculators, having failed to break recent lows at 4.41 percent, were testing the top of a week-old trading range around 4.50 percent. A break could open the way for a move to 4.59 percent.

Dealers emphasized that liquidity was so thin that even modest selling had an exaggerated impact on prices.

The benchmark 10-year note (US10YT=RR: Quote, Profile, Research) lost 12/32 in price, lifting its yield to 4.50 percent from 4.45 percent on Monday.

"There's been some leveraged, hedge fund selling in the belly of the curve. Seems to be fast money reestablishing short positions, maybe in the belief the recent rally has gone too far," said one trader at a U.S. primary dealer.

Yields on the 10-year note have fallen from as a high as 4.88 percent last month as signs of slower economic growth and a soft jobs report countered concerns the Federal Reserve would have to be aggressive in hiking interest rates.

"There's also talk that a certain West Coast bond fund is taking profits, you know the one that was turned so bullish on Treasuries a couple of weeks ago," added the trader.

Bond fund PIMCO made a well-publicized investment in the market in recent weeks, buying around $35 billion in Treasury notes and other high quality U.S. debt.

Whatever the identity of the sellers, the effect was all too apparent. Yields on the two-year note (US2YT=RR: Quote, Profile, Research) ticked up to 2.57 percent from 2.55 percent, while the five-year (US5YT=RR: Quote, Profile, Research) yield rose to 3.67 percent from 3.62 percent.

At the long end, the 30-year bond (US30YT=RR: Quote, Profile, Research) shed 15/32 in price, sending its yield to 5.23 percent from 5.20 percent.

The bond market was also weighed upon by a sharp narrowing in the U.S. trade deficit for May. This implied net exports would not subtract as much from GDP growth as many analysts had assumed. That could make the difference between second-quarter GDP coming in nearer to 4.0 percent than 3.0 percent.

"The second quarter was better than economists thought. There will be half a point or so upward revision to GDP, depending on the June figures," said James Glassman, senior economist at J.P. Morgan.

Faster growth could contribute to higher inflation and perhaps lead the Fed to hike more quickly than otherwise.

Still, other indicators, particularly on consumption, which accounts for 70 percent of the economy, suggest growth in the second quarter could still disappoint.

"The 'bean count' thus far from the monthly data points to little better than 2.5 percent to 3.0 percent growth in the most recent quarter," said David Rosenberg, Chief North American economist at Merrill Lynch, though that prediction was made before the release of the May trade numbers.

"This will not be conducive to an environment for the Fed to move rates up at each meeting for the rest of the of year and yet that is exactly what is still priced into the futures contracts," he added.

Fed Bank of Dallas chief Robert McTeer speaks later and, as usual, the market will be attentive to any comments on the economy and policy.

Optimists argue that consumption will revive again in the second half of the year. There was further evidence that consumer confidence had improved, with the IBD/TIPP's optimism index rising to 57.3 in July from 52.8 in June.

But the early signs on consumption were not so promising. The ICSC/UBS measure of chain store sales, for instance, was flat in the July 10 week, taking annual sales growth down to 3.4 percent from 4.4 percent the previous week.

The Redbook survey of chain stores showed similar softness, with annual sales growth slowing to 2.8 percent from 3.3 percent, suggesting demand has some way to go before meeting optimists' expectations for the third quarter.

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