Long End of Treasury Market Battered Following Rate Cut

Updated from 2:25 p.m. EST

Treasury notes and bonds, which had begun to pull back early from the immense gains made yesterday, sold off in furious spurts through the afternoon after the Federal Reserve announced an inter-meeting cut in interest rates. Bond prices stumbled and yields spiked upwards as money traders dissolved their positions, which lately had been overbought on the prospects of a recession.

"It is basically a knee-jerk reaction to the Fed move. People are looking at stocks and saying let's see how far this can go, and in doing so, they are adjusting their holdings in the bonds. But it really is just a reaction," said Avram Altaras, treasury market strategist at Bear Sterns.

The benchmark 10-year Treasury note fell 1 26/32 to 104 15/32, increasing its yield 23.2 basis points to 5.154%. It was its steepest price decrease in 20 months.

The 30-year Treasury bond fell 2 13/32 to 110 30/32, increasing its yield 15.2 basis points to 5.495%.

In a move the financial markets had been eagerly awaiting, the central bank lowered interest rates well before its monetary policy meeting scheduled for the end of the month. The federal funds rate was taken down 50 basis points, to 6%. The Board of Governors also approved a 25-basis-point decrease in the discount rate, to 5.75%, the level requested by seven Reserve banks. It remains willing to reduce the discount rate another 25 basis points if approached by the Federal Reserve banks.

"This is not an entirely unexpected move. The market had in fact discounted more than that," added Altaras, referring to the immediate rate cuts. He did note, though, that the equity markets took off immediately after the news.

In its press release, the Fed said it was taking the action in "light of further weakening of sales and production, and in the context of lower consumer confidence, tight conditions in some segments of financial markets, and high energy prices sapping household and business purchasing power." It however saw little evidence of "longer-term advances in technology and associated gains in productivity" abating.

Altaras believes the Fed did the right thing and so alleviated the fear of a recession, but foresees a "long way to go." He does not rule out the central bank making another rate cut during its meeting at the end of January. "Some of the economic data coming out is still going to be important in that aspect, as for example, the unemployment report."

Bruce Steinberg, chief economist at Merrill Lynch, echoed similar sentiments. Although he found the Fed announcement surprising, he said the move proved that "the Fed is not indifferent to the weakening economy and that they are prepared to take the necessary measures to prevent a recession."

What it did not mean, in his opinion, was that the economy would turn around at once. "There is a lag between a rate reduction and its economic impact. However, this announcement gives us more confidence in our belief that the economy will be strengthening by the second half of the year. In the meantime, we believe the economy will not be shrinking but just growing more slowly," he said.

At the Chicago Board of Trade, the March Treasury futures contract followed the market trend, dropping 1 27/32 to 104 14/32.

Economic Indicators

In other economic news, the weekly Mortgage Applications Survey (definition | chart | source ) detected a decrease in refinancing and new mortgage activity. The Refinancing Index fell to 757 for the week ending December 29, dropping noticeably from its 18-month high of 794.1 recorded the week before. The Purchase Index fell to 219.4, its lowest level since March 1998. A diminishing in consumer confidence and income growth are the probable cause of the decline, though some the data could be seasonal.

The BTM-UBSW Weekly Chain Store Sales Index (definition | chart ) rose 0.3%. The Redbook Retail Average showed December sales slowing down to 2.1%, as compared to 3.3% in November. Heavy discounting and promotion of goods helped lift sales towards the last part of the shopping season.

Construction spending (definition | chart | source ) fell 0.6% in November. Economists polled by Reuters had expected it to be unchanged for the month. The pace of construction spending, which benefits from low interest rates, fell to 4.7%, its second-lowest rate for the year, from 8% in October. There were fewer residential and public buildings built, while expenditure on non-residential buildings like offices and factories increased.

Currency and Commodities

The dollar fell against the yen and rose against the euro. It lately was worth 113.60 yen, down from 114.50. The euro was worth $0.9286, down from $0.9496. For more on currencies, see TSC's Currencies column.

Crude oil for February delivery at the New York Mercantile Exchange rose to $28.00 a barrel from $27.21.

The Bridge Commodity Research Bureau Index rose to 225.88 from 224.99.

Gold for February delivery at the Comex fell to $269.30 an ounce from $270.00.