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Ahead of FOMC Meeting, Long Treasury Makes a Little Progress

But shorter-term notes are frozen or lower as the probability of an announced tightening bias is figured.

The long Treasury bond rallied a bit but shorter-maturity notes were unchanged to lower on the day before the


monetary policy committee holds its third meeting of the year. Traders and analysts are divided about the meeting's probable outcome, with many predicting the committee will announce a shift to an official bias in favor of a higher fed funds rate, and many others predicting no change will be announced.

Today's trade mostly reflects fear of the former. An indication by the

Federal Open Market Committee

that it may have to raise the fed funds in the next few months would presumably have the effect of lifting short-term yields, while long-term yields would rise by smaller amounts, or even fall. Short-term yields tend to stay in the vicinity of the expected fed funds rate, while long-term yields exceed it by a margin that reflects inflation expectations. A higher fed funds rate typically leads investors to curb their inflation expectations.

The benchmark 30-year bond added 10/32 to 90 29/32 today, trimming 3 basis points from its yield to 5.90%. But the two-year Treasury note was unchanged, leaving its yield at 5.29%.

Market analysts say any move triggered by tomorrow's outcome is unlikely to go far.

If the FOMC, which in

December adopted a policy to announce changes in its bias "on those occasions when it wanted to communicate to the public a major shift in its views about the balance of risks or the likely direction of future policy," uses the procedure for the first time tomorrow and announces a shift to a bias in favor of a higher fed funds rate, analysts agree that the market is likely to go down, with notes suffering more than bonds.

"It's not 100% discounted, it's only 50% to 60% discounted,"

Bear Stearns

Treasury market strategist Avram Altaras said.

But even those who think the Fed should and will adopt a tightening bias (Bear Stearns doesn't) think the damage will be limited.

"The worst case I'm hearing is that the market falls 10 basis points," where the long bond's yield would be right around 6%, Altaras said. "That's not too far from here."

"Most of it's priced in," agreed Michelle Laughlin, Treasury market strategist at

Prudential Securities

, who also doesn't expect any announcement by the Fed. In the event she's wrong, she says the long bond will "definitely" test the 6% level and short-term yields will rise even more. "But the downside's gotta be somewhat limited," she said. "I don't think anybody anticipates that the Fed is going to move to be aggressively tightening. It's more a taking back of 25 to 50 basis points of ease."

The fed funds rate is the Fed's target for the rate banks charge one another for overnight loans. It has been 4.75% since November, when the Fed delivered the last of a series of three 25-basis-point cuts, starting in September.

The fact that a bias change doesn't guarantee a rate change will also help contain the damage, said David Ging, Treasury market strategist at

Donaldson Lufkin & Jenrette

, who expects the FOMC to announce a tightening bias.

They will do it, he says, "because the cost is small, and given what

Greenspan said in his

May 6

speech, the inflation data are a good way to do it. He gets the market to do the work for him. If he doesn't, he loses a marginal amount of credibility." The inflation data Ging's referring to is the April

Consumer Price Index

, which

Friday shocked the market with increases that were roughly twice as large as expected.

But, Ging said, "In the end they aren't going to tighten. Despite last week's numbers, there's not much inflation. You can't look at one month of data and say that's it." Accordingly, he said, the market will probably lose some ground on a tightening bias tomorrow, but should subsequently enjoy a "corrective rally" as the medicine takes effect.

There's less agreement about what will happen if the Fed does nothing. There's two schools of thought, Altaras says. Either the market goes down, because traders and investors think Greenspan & Co. are "asleep at the switch." Or it doesn't, because even if the Fed


adopt a tightening bias this month, the committee's next meeting on June 29-30 isn't very far off.

"People will shift their focus to the June meeting and set their sights on a bias shift at that time," Laughlin said.

But at the same time, Laughlin said, the market is unlikely to rally strongly if there's no announcement, because traders are worried that Friday's reports -- which also included a stronger-than-expected reading on April

industrial production

-- might be the start of a new trend. "The fear," she said, "will be that the numbers for May won't confirm that CPI and IP were aberrations."