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Treasuries Pare Losses After Court Finds for Gore

After struggling all day, the Treasury market recovered to end little changed after the 4 p.m. EST announcement that the Florida Supreme Court had ruled in favor of Democratic candidate Al Gore in the contested presidential election. The ruling gives Gore a chance of defeating Republican candidate George W. Bush, who had appeared increasingly likely to prevail.

The development -- the court ordered manual recounts of ballots rejected by counting machines, a process that could discover enough votes for Gore to erode Bush's narrow lead -- helps the Treasury market in two ways. It creates the possibility of further declines in the stock market, as buyers put their plans on hold until the race is decided. That increases the appeal of bonds as an alternative investment.

In addition, a Gore presidency, while by no means assured, is viewed as likely to run larger federal budget surpluses than a Bush presidency would, because Bush has promised larger tax cuts. Thus far, surpluses have been used to pay down the national debt by reducing the supply of Treasury securities, a policy that has increased their value.

The benchmark 10-year Treasury note , after trading down as much as 17/32, finished unchaged at 103 9/32, its yield 5.309%.

The 30-year Treasury bond fell 4/32 to 110 22/32, lifting its yield a fraction of a basis point to 5.512%.

At the Chicago Board of Trade, the March Treasury futures contract , which stops trading at 3 p.m. EST, fell 11/32 to 103 12/32.

For most of the session, an acceleration in the pace of wage growth and the stock market's rally weighed on Treasury prices, eroding the big gains that dropped yields to their lowest levels of the year earlier in the week. The wage-growth acceleration and the stock market rally both threw cold water on hopes that the Fed will cut interest rates in the very near future.

Profit-taking also took a toll, because prices had risen so sharply earlier in the week, market analysts said.

"We hit a wall in terms of going higher," Bear Stearns Treasury market strategist Avram Altaras said.

The wage growth news was part of the November employment report ( definition | chart | source ), which also measures job growth and unemployment. Job growth was weaker than expected, and the unemployment rate rose. Nonfarm payrolls increased by 94,000, vs. an average forecast among economists polled by Reuters of 137,000. The unemployment rate rose to 4% from 3.9%.

Those indicators portrayed a weakening economy. By themselves, they might have increased the likelihood of the Fed lowering interest rates in the next couple of months in order to keep the economy from slowing too much.

But a 0.4% rise in the average hourly wage, to $13.94 from $13.88, dampened hopes for an interest-rate cut. It caused the annual rate of earnings growth to rise to 4%, the highest in nearly two years, from 3.9%. A fast rate of earnings growth has the potential to cause inflation to rise by enabling consumers to buy more goods and services than the economy can produce. As long as the Fed sees the risk of rising inflation, it will hesitate to lower interest rates, even if growth is slowing.

The wage-growth acceleration "is going to keep the inflation hawks vigilant," said Gemma Wright, Treasury market strategist at Barclays Capital, referring to Fed officials who are least willing to risk an increase in inflation.

At the Chicago Board of Trade, traders of fed funds futures contracts downgraded the odds of a near-term interest rate cut. The odds that the Fed will lower the fed funds rate to 6.25% from 6.5% this month, indicated by the price of the December fed funds futures contract, fell to 36% from 41%. The odds of a 25- basis-point rate cut by the end of January slipped to 94% from 102%.

The stock market rally also sapped demand for Treasuries. Rising stock prices reduce the appeal of bonds as an alternative investment. In addition, they indicate that people are optimistic about the economy. Faster economic growth normally means higher interest rates and lower bond prices.

A selloff may have been inevitable in any case simply because Treasuries had racked up big gains earlier in the week. The rally started on Tuesday, when Fed Chairman Alan Greenspan acknowledged the risk that economic growth is slowing too much. On the theory that the Fed will cut interest rates to keep that from happening, note and bond prices rose, lowering their yields. From Monday to Thursday, the 10-year note's yield fell 23.6 basis points to 5.309% from 5.545%.

"It was an explosive week in terms of Treasuries rallying," Wright said. Traders have an especially strong inclination to take profits near the end of the year, she added.

Over the next several weeks, Treasury market participants will study data on economic growth and inflation in order to divine whether, how much and when the Fed will cut interest rates.

Currently, market analysts say, the Treasury market is pricing in a soft landing for the economy -- meaning a slowdown but not a recession -- and two 25-basis-point rate cuts. For it to continue to rally, Bear Stearns' Altaras said, either the possibility of a recession has to emerge, or inflation has to fall. Lower inflation rates would make it possible for the Fed to cut interest rates more than twice even if the economy averted a recession, he said.

Economic Indicators

In other economic news, the Future Inflation Gauge ( definition | chart ) fell to 115.1 in November, the lowest in 14 months. Leading indicators of inflation -- things like industrial commodities prices -- are suggesting that the inflation rate will fall.

The Consumer Sentiment Index ( definition | chart ) fell sharply in December on a preliminary basis, to 97.4, the lowest since October 1998, from 107.6 in November.

Currency and Commodities

The dollar rose against the yen and the euro. It lately was worth 111.01 yen, up from 110.55. The euro was worth $0.8862, down from $0.8892. For more on currencies, see TSC's Currencies column.

Crude oil for January delivery at the New York Mercantile Exchange fell to $28.30 from $29.35.

The Bridge Commodity Research Bureau Index fell to 230.58 from 230.98.

Gold for February delivery at the Comex fell to $275.20 from $276.10.

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