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Treasuries Surrender Gore-Gotten Gains

Treasuries gave back the gains they made on Friday, reflecting the weekend shift in the presidential contest in favor of Republican candidate George W. Bush.

Treasuries rallied on Friday after the Florida Supreme Court ordered recounts in Florida, a development that could make Democratic candidate Al Gore the victor. The bond rally was based on the prospect of continued stock market declines while the outcome of the election remains in doubt, and on the belief that Gore would do more than Bush to reduce the supply of Treasury securities by using federal government surpluses to pay down the national debt.

The Treasury market gave back those gains today after the U.S. Supreme Court Saturday halted the recounts pending a hearing. A rally in the stock market further sapped demand for bonds.

"Considering the Nasdaq's got some strength to it, and the peanut-gallery assumption that Bush is going to get the nod from the Supreme Court, the market trades extremely well," said Ken Logan, managing analyst at IFR/Thomson Financial.

The market was due for a correction, Logan said. To believe that it could continue to rally from last week's highs -- which corresponded to the lowest yield levels of the year -- one would have to expect either that the Nasdaq Composite Index would drop to new lows for the year, or that the November retail sales ( definition | chart | source ) report, to be released on Wednesday, will show an outright decline, he said. Evidently those propositions have few takers.

The benchmark 10-year Treasury note fell 13/32 to 102 30/32, lifting its yield 5.5 basis points to 5.354%.

The 30-year Treasury bond fell 14/32 to 110 10/32, lifting its yield 2.9 basis points to 5.536%.

At the Chicago Board of Trade, the March Treasury futures contract -- which closed at 3 p.m. EST on Friday, before the Florida Supreme Court ruling -- fell 2/32 to 103 10/32.

With no economic data on the calendar, volume was extremely light. According to GovPX $19.3 billion changed hands through 3 p.m., 15% less than average for a Monday over the past month.

Long-maturity Treasuries outperformed short-maturity ones -- meaning long-maturity yields rose less than short-maturity yields -- as the market continued to adjust to the idea, introduced by the November employment report ( definition | chart | source ) on Friday, that the Fed is under little pressure to lower interest rates in the near future.

Economic growth is moderating, and that is unequivocally good for long-maturity Treasuries, whose yields reflect inflation expectations, Morgan Stanley Dean Witter fixed-income strategist Kevin Flangan said. "There's no question the pullback in economic activity is beneficial for longer-dated securities because it will keep inflation at bay," he said.

Long-maturity issues will also continue to benefit from shrinking supply, at least for the next couple of years, regardless of who moves into the White House in January, Logan said. "Even if Bush gets in, you're looking at at least a year or two of budget surpluses."

Short-maturity Treasuries, on the other hand, also rallied hard last week on the assumption that the Fed would lower the fed funds rate in the next month or two. But the employment report was not so weak that it suggested the economy needs an immediate interest-rate cut in order to avert a recession. As a result, short-maturity yields are rising to reflect diminished odds of a near-term interest-rate cut. The two-year note's yield rose 5.1 basis points as its price fell 3/32, and the five-year note's rose 9.1 basis points as its price fell 12/32.

Bond traders, who can generally borrow money to invest in Treasury securities at a rate roughly equal to the fed funds rate (currently 6.5%), may be willing to buy long-maturity issues at yields lower than the fed funds rate, because long-maturity issues can increase greatly in price. They are less willing to buy short-maturity issues at yields lower than the fed funds rate, because short-maturity issues generally don't increase greatly in price unless the Fed lowers interest rates unexpectedly.

These dynamics will continue to cause short-maturity Treasuries to underperform long-maturity ones, the analysts predicted.

Currency and Commodities

The dollar fell against the yen and rose against the euro. It lately was worth 110.75 yen, down from 111.01. The euro was worth $0.8757, down from $0.8860. For more on currencies, see TSC's Currencies column.

Crude oil for January delivery at the New York Mercantile Exchange rose to $29.80 a barrel from $29.15.

The Bridge Commodity Research Bureau Index rose to 232.26 from 230.60.

Gold for February delivery at the Comex fell to $273.10 an ounce from $275.10.

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