Market Features

Return to Article

Bonds Scream Recession

Liz Rappaport

Stock and bond investors continued to take divergent views of the economy Thursday.

Treasury bonds soared, pushing the yield on the 10-year note to an 11-month low. The sharp fall in Treasury yields, which fall as prices rise, clearly betrays an expectation that the economy will slow.

But stock prices also rose Thursday, led by a sharp rally in the homebuilders -- considered by some observers to be among the economy's most vulnerable sectors. Stock investors, therefore, seem to be betting the economy will do just fine.

And without any Fed speakers Thursday to remind bond traders that inflation is still a concern, the bond rally got a bit out of hand. Various Fed officials, including FOMC chief Ben Bernanke, will speak Friday, and the bond market is likely to come off the boil again, sending yields rising back up.

"There are a few camps in the bond market," says Jack Malvey, chief fixed-income strategist at Lehman Brothers. "We would not be bond bulls and chase this rally."

The 10-year Treasury bond rallied 15/32, speeding its yield to 4.46% -- a low not seen since January. The 30-year bond jumped 26/32 to yield 4.56%, and the two-year note jumped 4/32 to yield 4.62%.

An unexpected surge in initial jobless claims, mixed reports of November same-store sales and a surprisingly low reading of manufacturing activity in the Chicago area supported the bond bulls.

What was largely ignored, however, was a higher-than-expected reading of the Fed's favorite measure of inflation -- the core personal-consumption expenditures deflator, which rose 0.2% in October against expectations of a 0.1% jump. This brings the inflation measure to 2.36% year over year, still near the upper end of the Fed's target range.

With Bernanke's hawkish comments Tuesday that inflation remains "uncomfortably high" ringing in some investors ears, the fed funds futures market put only 14% odds of a cut in January, up from 10% on Wednesday, notes Tony Crescenzi, chief fixed-income strategist at Miller Tabak and contributor to RealMoney.com. For the March meeting, the market upped odds of a cut to 50% from 46% and brought the chances of a cut in May to 100% up from 96% Wednesday.

But Bernanke's inflation warnings aside, evidence of poor growth fuels recession fears in the growth-obsessed bond market. The irony is that bond investors' pessimistic outlook brings down interest rates, which spurs investors' hopes for the housing market.

Thanks to the bond bulls, low yields limit the damage to consumers with adjustable-rate mortgages and fuel more home buying and refinancing. The average 30-year mortgage rate fell recently to 6.14% for the week ended Thursday, a level not seen since January of this year, according to data released by Freddie Mac.

To wit, homebuilder stocks soared again Thursday on low interest rates and news of an upgrade by Bank of America analyst Daniel Oppenheim. He cited improved buyer traffic, lower prices and bullish construction trends. Oppenheim was one of the first analysts to pull the plug on the homebuilder sector in 2005 when the residential housing market peaked.

Oppenheim upgraded shares of Standard Pacific(SPF Quote - Cramer on SPF - Stock Picks) to buy from sell and boosted shares of Toll Brothers(TOL Quote - Cramer on TOL - Stock Picks), Pulte Homes(PHM Quote - Cramer on PHM - Stock Picks), NVR(NVR Quote - Cramer on NVR - Stock Picks), Meritage Homes(MTH Quote - Cramer on MTH - Stock Picks) and Ryland(RYL Quote - Cramer on RYL - Stock Picks) to neutral from sell.

Shares of these stocks jumped between 5% and 11% Thursday.

Broadly, the major stock market indices struggled throughout the day to turn upward, but bulls overcame another day of higher oil prices and slow-growth fears.

The Dow Jones Industrial Average finished the day up 0.1% to close at 12,239.15, fighting against a 1% decline in General Motors(GM Quote - Cramer on GM - Stock Picks) on news that investor Kirk Kerkorian continues to sell his position in the automaker. Kerkorian and his investment firm Tracinda Corp. further cut the stake to 4.9% from 7.4%, according to a Securities and Exchange Commission filing.

The S&P 500 closed up 0.2% at 1402.44, and the Nasdaq Composite closed up 0.1% at 2434.77, while shares of Microsoft(MSFT Quote - Cramer on MSFT - Stock Picks) closed down 0.5% as the company released to the market its new operating system Vista. Retailers' shares were mostly down Thursday as November's same-store sales were largely disappointing. Wal-Mart(WMT Quote - Cramer on WMT - Stock Picks) confirmed its 0.1% decline in sales, sending its shares down 1.5%. The S&P Retail Index fell 0.1% on the day.

The dollar weakened again Thursday vs. the euro, the yen and the British pound on expectations for weak economic growth. The deeper the dollar drops, the more its weakness threatens to turn into an inflationary pressure as well.

The growth/inflation debate will continue Friday with comments from five Fed speakers.