Bond Brief: Snoozing Through the FOMC

Treasuries mainly ignore the last Greenspan policy statement.
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Updated from 4:22 p.m. EST

Most Treasury prices ended the day little changed after the

Federal Reserve

raised fed funds to 4.50% and issued a statement that pointed to inflationary pressures but gave few clues as to how new chairman Ben Bernanke will handle monetary policy. The 30-year bond rallied following the announcement.

"Although recent economic data have been uneven, the expansion in economic activity appears solid," the statement said, echoing previous language. "Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained."

Policymakers were noncommittal regarding their March 28 meeting. "The committee judges that some further policy firming may be needed" to preserve the economic balance, their statement said. On Dec. 13, policymakers said that "some further measured policy firming is likely to be needed."

The benchmark 10-year note closed up 2/32 of a point to yield 4.32%, down from 4.53% late Monday. The yield had dropped to 4.52% before the announcement, and it hit a high of 4.55% after the rate hike. Prices and yields move in opposite directions.

In shorter-dated debt, the five-year note added 1/32 to yield 4.45%, while the two-year edged lower 1/32 to yield 4.52%, on par with the 10-year yield. Longer-dated maturities usually yield more to compensate investors for taking on the additional risk of a longer-term loan.

The 30-year bond saw more action, rallying 14/32 of a point to yield 4.68%, after falling as much as 7/32 of a point to yield 4.72% immediately following the Fed news.

The long bond had soared ahead of the announcement on news that in January, pension funds and insurance companies grabbed up $10.6 billion in corporate bonds with a maturity of 30 years. That rate of purchases has not been seen since 1997, according to a report from

Bloomberg

, and it implies an unusual tolerance of inflation risks normally associated with investing over such a long period.

"I would not make much out of the current reaction," says Bulent Baygun, head of U.S. fixed-income strategy at Barclays Capital.

"Whether the Fed stops raising rates at 4.5% or 5.0%, what's important is that it looks like we're coming to the end," he says. "As a result, current yield levels are starting to look attractive, even for long-term investments."

Baygun also adds that the influence of pension reform will continue to keep the 30-year yield low. "Investors are beginning to take this

pension issue more seriously now, and you'd expect these flows to benefit the back end of the curve."

The afternoon interest rate announcement marked the end of Alan Greenspan's tenure as head of the central bank, and it resulted in the 14th straight rate hike in this latest monetary tightening cycle. Even though the overnight lending rate is still historically low, it is now at its highest level in more than four years.

The statement dropped the word "measured," which has accompanied every rate hike since May 2004, a move that suggests economic data will determine future rate decisions.

All things considered, the release was pretty boring, says Frank Bifulco, a private bond investor and former fixed-income strategist at Deutsche Bank. "Everything as expected, nothing implied or wink-winked at all," he says.

The new language reinforces that rate future hikes will be data-dependent, said David Ader, bond strategist at RBS Greenwich Capital, adding that this leaves the door open for Ben Bernanke to hike, or not, at his first meeting as Fed chairman in March.

"Now that the meeting is out of the way, the next stop is the employment report," says Baygun. "That could influence perceptions about growth to a large extent and could provide some upward pressure on yields."

Fed funds futures continue to show 84% odds for an interest rate hike in March that would bring the fed funds rate to 4.75%.

With policymakers chained to data, the market will likely see some choppy, rangebound trade ahead, says John Herrmann, director of economic commentary for Cantor Viewpoint.

"The data has not been coming out as clearly as we'd like, or need, in order to see clear policymaking," he says. Murky consumer spending is one example of this problem, Herrmann says, pointing out that retail sales for December came in really soft, but that consumer spending numbers for the month were much stronger than expected.

"We're going to see a lot of this sort of contradictory data, combined with a lot of back number revisions, because there are many events working their way through the numbers," says Herrmann, including the impact of last fall's hurricanes and defense spending. "Government and state agencies have a tough time getting an accurate read, and that will complicate things for the Fed and the market's interpretation of the Fed."

Tuesday's weak report on wages adds to the idea that inflation remains subdued. The Labor Department said its employment-cost index rose a seasonally adjusted 0.8% in the fourth quarter vs. expectations for a 0.9% rise. Adjusted for inflation, overall compensation fell by 0.3% in 2005, the first annual decline since 1996.

In other economic news, consumer confidence rose in January to the highest since June 2002 to a stronger-than-expected 106.3, vs. expectations for a rise to 105. The December level was also upwardly revised.

Meanwhile, the January Chicago manufacturing index fell 2.3 points to 58.5, vs. forecasts for a smaller dip to 59.8.

Plenty more economic reports are on tap, including readings on auto sales, construction spending, manufacturing and the January payroll report, which the Fed will scrutinize for signs of wage inflation.

"On that score

data, the bias is skewed bearishly ... and the interpretation of fourth-quarter weakness is that it gives first-quarter strength," writes David Ader, bond strategist with RBS Greenwich Capital, in a note.

Moreover, the Treasury will announce Wednesday the size of its quarterly refunding auctions, which includes the reintroduction of the 30-year bond.

Barclay's Capital expects the refunding of 30-year, 10-year and three-year notes to total $46 billion. Like RBS, the firm is one of 22 primary U.S. government securities dealers that are required to participate in Treasury auctions.

Treasury demand will be closely watched, as U.S. securities posted their biggest price declines since October on week foreign demand.

Ramped-up demand for Treasuries from overseas investors and pension funds have kept long-term yields historically low, and the market has been sensitive to any evidence that those buyers are diversifying away from the Treasury market.

The government said yesterday that it will borrow a record $188 billion this quarter, $17 billion more than previously forecast.