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Bond Brief: Five-Year Gets Flogged

Longer-dated Treasuries drop, but the five-year gets the worst of it a day after a disappointing auction.

Updated from 10:05 a.m. EST

The Treasury market slid Friday afternoon, even after a report on durable goods orders plummeted, as traders saw strength beyond the headline number and looked ahead to next week's full calendar of heavy-hitting economic reports.

Most recently the benchmark 10-year note was down 3/32 of a point to yield 4.57%, while the 30-year bond lost 9/32 to yield 4.52%. Bond prices and yields move in opposite directions.

In shorter-dated debt, the two-year was little changed on the session to yield 4.72%, and the five-year lost a whopping 20/32 of a point to yield 4.63%.

The five-year note is still seeing the effects of the previous session's disappointing $14 billion auction. At the auction, the issue drew a 2.18 bid-to-cover ratio, vs. the 12-month average of 2.48.

More importantly, indirect bidders, a category that includes foreign central banks, took 21.3% of the issue, much lower than the 12-month average of 37.2%. Foreign investor participation is closely monitored, since sturdy foreign Treasury buying has kept long-term rates low in the U.S., fueling sectors including housing and consumer spending.

The Commerce Department said durable goods orders for January dropped a surprisingly large 10.2% vs. the consensus estimate for a 2.0% dip. After stripping out the transportation component, durables rose a better-than-expected 0.6%, compared with estimates for a 0.5% rise.

"We have to come to the understanding that most of the durables contracts were coming out of


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... as those slowly fade, then we'll get some real numbers," says Matthew Smith, vice president and fixed-income portfolio manager at Smith Affiliated Capital.

Smith agrees with recent

Federal Reserve

officials who have said that inflation is still well-contained, even though they're monitoring signs of economic strength.

"Inflation in terms of the CPI numbers that have come out has been in line with previous months," says Smith. "If you look at the rest of the world, inflation in China and in Japan is hovering around 1.9% and 2%. It looks like global inflation is contained, too."

Even so, the market has been given some scares of late, including Thursday's better-than-expected weekly initial jobless claims reading, which fell to 278,000 from 298,000 the week earlier. A slight increase to 300,000 had been forecast.

Fed policymakers have been carefully monitoring the employment picture because the U.S. is close to full employment, or the lowest level of unemployment possible before wage inflation sets in. Bond traders loathe inflation because it erodes the value of fixed-income investments.

In this data-dependent era of policymaking, next week's full roster of economic reports will be closely watched. These include the January reading on home sales, a second look at the fourth-quarter GDP, consumer confidence for February and several key manufacturing reports.

Michael Darda, chief economist at MKM Partners, says the economy is more healthy than the bond or equity markets are giving it credit for. He's looking for an upward revision to the fourth-quarter GDP based on the other data that's been released in recent weeks.

Darda says the general theme going forward is going to be a strong economy, with good underlying fundamentals.

"The Treasury market has priced in a funds rate going to 5%, but rate cuts by the end of the year," he adds. "I see cuts as a zero probability."

According to Miller Tabak, the market is now pricing in 100% odds that the Fed will lift rates at least two more times over the next three rate-setting meetings, taking its key rate to 5% by mid-June. Odds that the rate will rise to 5.25% in August were priced in for the first time Thursday. The market sees a 10% chance of such a move.

With the economic data out of the way, investors shrugged off speeches from Fed Vice Chairman Roger Ferguson and St. Louis Fed President William Poole. Ferguson delivered a speech on education in Baltimore. Poole, who is not a voting member for the Fed's policysetting committee, spoke in St. Louis.

Earlier in the week, Ferguson announced his resignation, effective April 28.

The only comments that will really matter to the market will be those made by Fed Chairman Ben Bernanke, who will talk about central banking after the market closes.