Treasury Yields Reach New Highs Amid Nasty Rumors

With friends like the bond market, who needs enemies?

Despite a Consumer Price Index in line with expectations, Treasury issues finished the day lower, pushing most yields to new highs for the year.

Initially, bonds rose in price on the news that the September CPI gained 0.4% overall and 0.3% at its core, which excludes food and energy prices. Those increases matched the average forecasts of economists polled by Reuters. The CPI is the government's broadest measure of inflation, and the fact that it didn't greatly exceed expectations, as the narrower Producer Price Index did on Friday, allowed hope that the Fed won't hike interest rates again at its next meeting, Nov. 16

But in the afternoon, two unconfirmed rumors swept the market, triggering selling. The rumors were of a familiar species in the Treasury market: Secretive purveyor of high-priced advice to money managers is predicting interest rate hikes. One rumor had a D.C. think tank forecasting at 50-basis-point November rate hike by the Fed. The other had a New York hedge fund adviser calling for a hike by the European Central Bank as early as Thursday.

Fed Chairman Alan Greenspan gave a midday speech to an Atlanta Fed meeting in Georgia via teleconference, but had no comment on the near-term outlook for monetary policy.

The benchmark 30-year Treasury bond ended the day down 11/32 at 97 1/32, lifting its yield 3 basis points to 6.35%, its highest close since Oct. 22, 1997. Shorter-maturity note yields also rose to new two-year highs, with the exception of the five-year note.

"Whatever" was a common reaction to the rate-hike rumors.

"Those guys have had a less-than-stellar track record, but when the market is jittery, any source becomes a reliable source," said Michael Ryan, senior fixed-income strategist at PaineWebber.

The reaction to the rumors highlights the bond market's persistent ill-humor after 12 months of falling prices, observed John Canavan, Treasury market strategist at Stone & McCarthy Research Associates in Princeton, N.J. "It remains far easier to push this market down than up, and that's probably going to remain the case till we see what the Fed does next month."

Market analysts also pointed out that short-covering was at least partly responsible for the market's favorable response to the CPI release. The long bond traded up as much as 17/32 in the hours after the release. Some players had taken short positions on Treasuries in hopes of capitalizing on a selloff in the event the CPI, like the PPI, printed much stronger than expected, Ryan said. When that didn't happen, they closed out the positions, sending the market higher.

At the same time, he said, there were players who were "genuinely buoyed" by the favorable CPI report, and by the September housing starts report, which showed a larger than expected drop in starts, and an even larger drop in building permits, a predictor of starts. Starts dropped to a 1.618 million pace from 1.672 million in August, while permits dropped to 1.501 million from 1.619 million.

The stock market rally also kept bonds from hanging onto their gains today, Ryan said. In recent sessions, bonds have been trading in inverse lockstep with stocks, rising when stocks fall and falling when stocks rise.

He thinks that's likely to continue in the days ahead. And together with the economic data slated for release between now and Nov. 16, the action in stocks will help determine what the Fed does. "If stocks go down another 8% to 10% from here, that could certainly help sideline the Fed," Ryan said.

A protracted stock-market selloff could avert a Fed rate hike if the Fed believes collapsing stock prices will slow the economy to a sustainable rate by undermining consumer confidence and curbing consumer spending.