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Bond Brief: Shaking Off PPI

Treasuries rally despite evidence of rising core inflation at the producer level.

Updated from 11:01 a.m. EST

Treasuries ended Friday's truncated session with a bang amid a low consumer-confidence reading and some flight-to-safety buying ahead of a long holiday weekend. A stronger-than-expected producer price index reading went by the boards.

Despite a signal that higher energy prices have nudged core inflation higher, the benchmark 10-year note ended the day up 12/32 to yield 4.54%, while the 30-year jumped nearly a full point to yield 4.51%. Bond prices and yields move in opposite directions.

In shorter-maturity debt, the five-year added 4/32 to yield 4.55%, and the two-year added two ticks to yield 4.66%. The action on the long end pushed the yield curve to its most inverted level since 2000, when it preceded a recession. (

Click here for more on the inverted curve.)

While a yield curve inversion has historically preceded economic slowdowns,

Federal Reserve

Chairman Ben Bernanke said during his two-day congressional testimony that the inverted yield curve is not a major concern.

He argued that inversions have predicted recessions when interest rates are generally high, since this tends to restrain activity. However, he said short-term rates are still in a "fairly normal range" and that long-term rates are "low, historically speaking," even after 14 straight quarter-point rate hikes.

The seasonally adjusted PPI report for January rose by 0.3%, vs. estimates for a 0.2% rise. But it was the core number, excluding food and energy, that really surprised to the upside. The Labor Department said that it rose by 0.4%, double what Wall Street had estimated.

"We can't blame fuel this time around," says Peter Cardillo, chief market analyst with SW Bach & Co. "This is where the inflationary buildup is, in the core number."

In a boost to the market, the University of Michigan consumer sentiment index for February came in at 87.4 vs. consensus estimates for a mild dip to 91.0 from 91.2 in the previous month.

"The Treasury market could also be seeing some flight-to-quality because of the

shaky geopolitical situation," says Cardillo.

With U.S. markets closed until next Tuesday for the President's Day holiday, investors could be moving into bonds to shelter themselves against three days of global uncertainty.

Some of the many global events that could be making investors nervous include a general strike that has shut down the port city of Karachi in southern Pakistan as protests continue across over the publication of caricatures of the Prophet Mohammed.

U.N. investigators and British cabinet member Peter Hain are calling for the U.S. to close its prison camp at Guantanamo Bay, the Taliban has killed six in an attack in Afghanistan, and kidnappers killed five bodyguards before abducting an Iraqi banker and his son.

And a mudslide has buried hundreds of homes and an elementary school in the eastern Philippine village of Guinsahugon, killing an estimated 300 and leaving another 1,500 missing, according to Red Cross statements.

Moreover, the fear of inflationary pressures and more interest rate hikes now seem par for the course on Wall Street, cushioning the Treasury market a bit from all but the strongest economic readings.

Bernanke gave the market fair warning that there would be strong economic readings and more hikes on the way, says Cardillo.

"He said the Fed is going to need to fine tune the economy ... and he was referring to inflation," Cardillo says. "They've priced this in."

While many remain baffled by the market's reluctance to sell off in light of this week's decidedly bearish events, "we take comfort in the resilience as it supports our longer term bullishness," says a research note from David Ader, U.S. government bond strategist at RBS Greenwich Capital.

"Despite the relatively high volumes on Tuesday and Wednesday, the sense is that the market has priced in as much of the tightening through the May 10 FOMC meeting as its willing to. Fed fund futures continue to fully price in a quarter point hike in March with better than even odds of a move to 5% in May," Ader adds.

Moreover, John Herrmann, director of economic commentary for Cantor Viewpoint, has argued that the more hawkish the Fed seems, the more it reassures the long-end of the market. This keeps demand for long bonds high and the yields low, Herrmann says. Cantor Viewpoint is a unit of Cantor Fitzgerald, one of the world's top Treasury bond brokers.

Fed Chairman Bernanke's long-awaited first speech came and went with little fixed-income market reaction, as he steered a Greenspan-esque course through the congressional grilling.

Like the Fed policy makers who spoke before he testified before the House Financial Services Committee and the Senate Banking Committee, the new chief said that the economy is on strong footing, that inflation is being closely monitored and that further rate hikes seem likely in the near future, depending on the economic data.

In other news, the Treasury reported that foreign holdings of Treasury and agency debt rose by $12.644 billion last week, and that holdings as of yesterday high $1.557 trillion.