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30-Year Treasury's Yield Moves Back Above 10-Year's

A disarmed Fed and whiffs of inflation begin to restore normalcy in the bond market.

Bond prices rose thanks to another decline in oil prices and growing optimism about the monetary policy outlook. Interestingly, the 10-year Treasury note outperformed the 30-year bond to such a great extent that its yield dropped below the bond's yield. Since mid-January, the 10-year note's yield had been higher than the bond's yield.

Treasury market participants attributed the so-called disinversion of the Treasury yield curve partly to growing concern about inflation, resulting from oil prices over $30 a barrel. But it also has much to do with the combination of heavy issuance of corporate bonds this week and poor liquidity in long-maturity Treasuries, they said. And, they pointed out, because long Treasury yields depend on federal fiscal policy, a strong trend is unlikely to emerge before Election Day.

The benchmark 10-year note gained 11/32 to 100 4/32, dropping its yield 4.8 basis points to 5.731%. Shorter-maturity yields fell by similar amounts.

The 30-year bond gained 9/32 to 107 10/32, lowering its yield 2 basis points to 5.733%. At the

Chicago Board of Trade

, the December

Treasury futures contract rose 9/32 to 99 30/32.

With no major economic data on the calendar, Treasury bond traders focused on oil and the corporate bond market, where new-issue volume is running high. According to

IDEAglobal.com

, corporate issuers are on pace to sell about $14 billion of new bonds this week, double the year-to-date average.

Heavy corporate bond issuance can weigh on Treasury prices, since investors may sell Treasuries in order to buy new corporate bonds. Or, underwriters may sell Treasuries well in advance of a large corporate bond offering as a hedge and buy them back afterwards. Treasury market watchers noted some of that activity today.

Meanwhile, oil cooperated with the bond market, retreating for the second day in a row. Even though high energy prices can act as a drag on the economy, an outcome the bond market benefits from, they are also potentially inflationary, an outcome no one benefits from. So bond prices have been moving in the opposite direction as oil prices and that continued today.

Further benefiting the bond market, futures traders downgraded the chances that the

Fed will hike interest rates again this year to the lowest levels ever. The December

fed funds futures contract put the odds of a hike in the rate (from 6.5% currently to 6.75%) at just 5%, down from 21% yesterday.

All three factors contributed to the disinversion of the Treasury yield curve between 10 and 30 years, market analysts said.

Because short-maturity Treasury yields are hemmed in by monetary policy, the Treasury yield curve tends to flatten or invert when the Fed is in a rate-hiking mode. With the Fed widely presumed to be finished hiking rates, "there's only one thing to do and that's for the curve to steepen again," said a 30-year bond trader at a primary dealer firm.

At the same time, high oil prices are fanning fears of an acceleration in inflation. When investors feel threatened by inflation, they demand long-term bond yields that are high relative to shorter-term bond yields. "Though we had a brief reprieve from crude oil, some concerns about inflation are filtering back into the market," the trader said.

Meanwhile, the supply of corporate bonds is more or less evenly distributed across the maturity spectrum, with corporate issuers selling a combination of five-, 10- and 30-year debt. To the extent that investors and underwriters sell five-, 10- and 30-year Treasuries, the 30-year Treasuries suffer the most price damage because they are the least liquid, the trader said.

Few Treasury market participants would be surprised to see the Treasury yield curve continue to disinvert due to this combination of factors. But they are also well aware that Nov. 7 could usher in a new era of inflation expectations, depending on what combination of powers captures the White House and Congress. Today's developments are "minor compared with the implications of the election to the curve,"

Merrill Lynch

government bond strategist Jerry Lucas said.

Economic Indicators

The weekly

Mortgage Applications Survey

(

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definition |

chart |

source

) detected increases in both refinancing and new mortgage activity, against a backdrop of falling mortgage interest rates. The Refinancing Index rose to 452.9, the highest since November, from 404.5. The Purchase Index rose to 324.4 from 307.4. Last week, mortgage giant

Freddie Mac

said its average 30-year mortgage rate was 7.94%, the lowest since December.

In other economic news,

import prices

(

definition |

chart |

source

) rose 0.2% (0.1% excluding oil imports). The annual rate of increase for import prices fell to 5.8% from 6.8%. Excluding oil imports, the annual rate held steady at 1.6%.

Currency and Commodities

The dollar rose against the yen and the euro. It lately was worth 107.07 yen, up from 106.83. The euro was worth $0.8588, down from $0.8635. For more on currencies, see

TSC's

Currencies column.

Crude oil for October delivery at the

New York Mercantile Exchange

fell to $33.82 a barrel from $34.28.

The

Bridge Commodity Research Bureau Index

fell to 229.83 from 230.74.

Gold for December delivery at the

Comex

fell to $276.50 an ounce from $276.60.