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OFF THE RUN: Gloomy Treasurys Take Another Turn For Worse January 25, 2007

Posted by notapundit in Economic News.
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NEW YORK (Dow Jones)–A sense of doom and gloom has hung heavy in the Treasurys market for the last few weeks, amid signs of a healthy economy and a Federal Reserve unlikely to ease interest rates anytime soon.

Thursday, the market’s tone soured even more, with the ten-year yield pushing up to a multi-month high as existing home sales data showed some signs of stabilization in the one sector widely seen as the economy’s Achilles heel.

By midafternoon,, the benchmark ten-year note was down 13/32 point at 4.87%, the highest it has been since mid-August. The 30-year note was down 21/32 point at 4.96% and the two-year issue, the most sensitive to official interest rate changes, was yielding 4.97%. The two-year yield hasn’t been above 5% since mid-August.

“Right now there are not a lot of positives,” said John Spinello, Treasurys strategist at Jefferies & Company in New York. “The psychology of the market is horrible, and to some extent, justified with information so altered from what was was previously thought. The market is continuing to adjust to stronger growth.”

Given the persistent gloomy bent to Treasurys, market participants aren’t banking on a speedy recovery for bond prices. But after a quiet data week, next week’s slew of typically market-moving data – in particular Friday’s employment data – as well as the Federal Open Market Committee meeting could potentially serve as a catalyst to shake investors free from their bond-negative mood.

If bonds get through the next few weeks of data and the government’s February refunding without breaking higher in rates, “that would be a good signal that the coast is clear,” said George Goncalves, Treasurys trading strategist at Banc of America Securities in New York.

Changing The Story Line

Since hitting their lows in early December, bond yields have been steadily rising into the New Year as investors have increasingly reduced expectations of a rate cut. The ten-year note hit a low yield of 4.43% early December, and Thursday afternoon was more than 40 basis points from where it was less than two months ago.

Recent data have shown the U.S. economy to be in no great need of a boost, an outlook supported by the strength of the labor market as evidenced by the government’s last nonfarm payrolls report. Consumer demand as of late has also looked robust, leaving bond holders uninspired.

“The big story is a two-month story – the replacing of growth and the Fed,” said Scott Gewirtz, head of Treasury trading at Lehman Brothers in New York. “You’ve gone from a housing-led recession to a more stable housing market and much better fourth quarter growth then expected,” he said. Some economists had previously estimated growth to be below 1.5%, but expectations are now at twice that level, he said.

A weaker-than-expected GDP figure next week could turn the market tone around, added Gewirtz, with the unemployment data also an obvious place to look. “If we start to see the employment rate shake a little bit,” Gewirtz said, “I think the tone of the market will change.”

Data next week would have to come in considerably stronger-than-expected to move rates much higher, added Jefferies’ Spinello, as the market has already begun to price in positive data. If numbers exceed expectations, Treasurys should see “more of a violent reaction,” he said, “and more acceleration of the move to higher rates.”

Rate Hike Unlikely

With recent bond-negative economic news, some fixed income investors have even begun to chatter about a possible future hike in interest rates, compared with the widely expected ease just months ago. But most market watchers think a hike is a largely unlikely scenario.

“You would need to see a lot more (positive) data,” Gewirtz said, “three quarters in a row of above-trend growth. Then you could see a hike on the table.”

Jefferies’ Spinello said that while a rate hike “isn’t out of the question,” he thinks policymakers will “hold a steady hand” and not be “too quick to tighten.”

The Fed has left interest rates steady at 5.25% for the last four meetings running. Federal Reserve officials – who have continued to cite concerns over too high inflation – will meet again on Jan. 30 and 31, and are expected to leave rates unchanged, with all eyes on the post-meeting statement.

If Fed officials allude next week to risks of a stronger economy, then “the assumption will be we’re close to a tightening,” said Spinello.

Concerns the Fed could perhaps sound more hawkish than the bond market currently thinks could also be what’s driving the selloff in the stock market – where the Dow Jones Industrial Average had lost 101 points by midafternoon, said Tony Crescenzi, bond market strategist at Miller Tabak & Co.

Michael Cheah, portfolio manager at AIG SunAmerica Asset Management in Jersey City, N.J., said the question investors must now ask themselves is, has the market sold off enough to correct the change in sentiment?

“If one were to remain negative, one would have to come up with the scenario that the Fed would raise rates,” said Cheah. “I think there’s only a small chance (of a hike). If the Fed were to raise rates, they will crush the housing market and politically it is indefensible because there’s no inflation. The Fed knows that nominal and core inflation numbers are coming down.”

So what will it take to turn the bond market around? Cheah said bond holders will need to see a hefty drop in jobs next week, together a soft manufacturing report from the Institute of Supply Management.

Gewirtz said market participants will also be looking to reports with the hopes that data will be “more realistic.”

“People are getting conditioned to stronger numbers,” Gewirtz said. “Next week will be telling, and…economic data not skewed by the warm weather could potentially lend some support.”

By Deborah Lynn Blumberg, Dow Jones Newswires

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