As Stocks Keep Dropping, So Do Bond Yields

An extremely weak report on the state of the manufacturing sector also gave bond investors reason to hope that the Fed will lower interest rates.
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Treasuries rose in response to the latest leg down in stock prices, dropping yields to new lows for the year. Falling stock prices suggest to bond investors that economic growth will continue to slow in the months ahead, possibly prompting the

Fed to lower interest rates.

Early in the session, two economic reports suggested, one of them strongly, that the economy is faltering. But the bond market largely ignored them. The rally started later, when stocks hit the skids.

"The market is taking an increasingly pessimistic view on the state of the economy going forward,"

Merrill Lynch

bond market strategist Gerry Lucas said. "It has a lot to do with the selloff in equities. Any selloff in the equity markets is much reducing the wealth effect." In other words, as stock prices fall, consumers become less willing to spend money, and the economy slows.

Treasuries got an additional boost late in the day from the fact that it was the last business day of November, a day when some investors buy Treasuries automatically.

The benchmark 10-year

Treasury note rose 9/32 to 101 31/32, dropping its yield 9 basis points to 5.484%, the lowest since May 1999.

The 30-year

Treasury bond rose 10/32 to 109 4/32, dropping its yield 3.2 basis points to 5.613%.

At the

Chicago Board of Trade

, the March

Treasury futures contract rose 26/32 to 102 19/32.

The logic of the rally was this: The more stock prices fall, the more valuable Treasuries become, for two reasons. First, because bonds hold their value much more reliably than stocks. Second, because falling stock prices threaten to slow the economy. If economic growth slows enough, the Fed will presumably lower the

fed funds rate as a stimulus.

"There is definitely some getting out of the way, rather than seeing fundamental value" in Treasuries, said Mike Cloherty, market strategist at

Credit Suisse First Boston

. "But it's pretty clear there's been a dramatic shift in market expectations about what the Fed's going to do."

People are surer than ever that the Fed will lower the fed funds rate in the next few months. For the first time,

fed funds futures contracts discounted more than 100% odds that the fed funds rate will be 6.25% by April, down from 6.5% currently.

"The Fed is definitely going to a neutral bias at the December meeting," Merrill's Lucas said, meaning that the

Federal Open Market Committee will declare the risks to the economy balanced between rising inflation and slowing growth in its

policy statement. Before the FOMC lowers the fed funds rate, Treasury market participants believe, it will shift first to a balanced statement, then to a statement highlighting the risks to growth. By that calculus, the first opportunity for the FOMC to cut rates at a scheduled meeting would come on March 20.

Earlier, Treasuries, which have been rallying for months on the expectation that economic growth would slow, largely ignored evidence that the slowdown is at hand.

The

Chicago Purchasing Managers' Index

(

definition |

chart ), which gauges the health of Midwest-based manufacturing companies, plunged to 41.7 in November, its lowest reading since April 1991, from 48.7 in October. Economists polled by

Reuters

had forecast a slight rise to 48.9, on average. Readings below 50 indicate that the Midwest manufacturing sector is contracting rather than growing.

"Today's data was the first piece that clearly said there might be something going on here," Credit Suisse's Cloherty said. "Then again, it's really only one report. We've got a lot left to go before the Fed's really going to get active."

Tomorrow, the

National Association of Purchasing Management

will release the

Purchasing Managers' Index, the national version of the Chicago report. The Chicago results have bond market pros particularly anxious over what it might say, since the Chicago results often foreshadow the national ones.

The latest weekly

initial jobless claims

(

definition |

chart |

source

) reading also benefited Treasuries today. First-time claims for unemployment insurance rose to 358,000, the highest level since July 1998, from 339,000 the previous week. The four-week average rose to 343,000, also the highest since July 1998, from 331,000. The numbers indicate that demand for workers is easing as the economy slows.

Finally, Treasuries got a boost from the calendar. It's not unusual to see Treasuries rise on the last days of November, February, May and August because the Treasury Department issues new securities during those months, in the

quarterly refunding. Indices that track the bond market incorporate the new securities on the last day of the month, at which point investors who mimic those indices buy them.

Economic Indicators

In other economic news,

personal income and consumption

(

definition |

chart |

source

) showed the first decline in personal income since December 1998 and the smallest increase in spending in six months in October. Personal income fell 0.2%; consumption rose 0.2%.

The

APICS Business Outlook Index

(

definition |

chart |

source

) drew a different conclusion about the health of the manufacturing sector than the Chicago PMI. It rose to 54.9 in November, the highest in over a year, from 53.5 in October.

Finally, the

Help-Wanted Index

(

definition |

chart |

source

) edged up to 79 in October from 78 in November.

Currency and Commodities

The dollar fell against the yen and the euro. It lately was worth 110.35 yen, down from 111.26. The euro was worth $0.8728, up from $0.8524. For more on currencies, see

TSC's

Currencies column.

Crude oil for January delivery at the

New York Mercantile Exchange

fell to $33.82 a barrel from $34.63.

The

Bridge Commodity Research Bureau Index

rose to 229.79 from 228.07.

Gold for February delivery at the

Comex

rose to $273.30 an ounce from $269.60.