Update from 10:49 a.m. EST
Prices on longer-dated bonds fell Thursday as traders worried about the inflationary implications of a big dip in jobless claims. New debt also weighed on the market, with
selling $1 billion in bonds with no fixed maturity and
announcing that it will sell $1 billion in bonds.
The Treasury said it will be offer $37 billion in three- and six-month bills on Monday to raise approximately $1.33 billion in new cash.
The benchmark 10-year note lost 11/32 to yield 4.37%, up from 4.33% late Wednesday. The 30-year bond fell 19/32 to yield 4.55%, up from 4.51% the previous session. And the five-year ended the day down 6/32 to yield 4.31%. Bond prices and yields move in opposite directions.
The two-year note lost two ticks to yield 4.37%, on par with the yield on the 10-year note; while the three-month Treasury was up one tick to yield 4.34%.
Typically, the yields on longer-dated maturities are higher than on shorter-dated ones. An inversion between the two ends of the curve has historically signaled an economic slowdown or recession, particularly an inversion of the spread between 10-year and three-month Treasuries.
"This is the yield spread the
is most concerned with," according to a research note from brokerage Miller Tabak. "Once the inversion rises to the midteens
in terms of basis points, odds of a recession within four quarters jumps to 30%."
But inflationary economic data won investor attention in the morning, as the weekly jobless claims signaled to the market that Federal Reserve had not raised rates enough to stymie economic growth.
Federal Reserve officials have hinted in speeches past that they are 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.
"The signs and symptoms of inflation have been there for a while and the bond market hasn't been concerned about it because it has thought that the Fed isn't concerned about it," says Michael Darda, chief economist at MKM Partners.
"There is an economic recovery underway that is deepening and broadening, but the market has been priced for no growth and no inflation," says Darda. But, he adds, that assumption will be challenged in 2006.
The Fed's beige book of economic activity also showed that labor markets have "tightened" in some districts, but that wage gains remain moderate. Philadelphia, New York, Boston and Minneapolis also noted significant price increases in energy-related costs, and some manufacturers said they will hike prices to cover these additional expenses.
Speaking Thursday afternoon, Dallas Fed President Richard Fisher said that looking at the "entrails of what we call the Beige Book, it's pretty clear that from Richmond down through Atlanta down to Florida across the southern tier of the United States and up the West Coast, we are growing very, very strongly." However, he added that there was weakness "in the northern tier and the Midwest."
Adding to the inflation-fear fire, Richmond Fed President Jeffrey Lacker said in a speech Wednesday that the 2006 economic outlook "fairly encouraging," in a bid to dispel fears that the economy is slowing too fast.
"Employment is expanding again at a healthy pace, consumer spending continues to grow briskly and business investment spending is robust,'' said Lacker, a voting member of the Fed's policy making Open Market Committee.
The February crude contract closed up $1.10 at $66.83 a barrel, as tension in producer countries Iran and Nigeria offset a greater-than-expected rise in U.S. fuel inventories. Persistent strength in oil prices has sparked a debate over whether they will act as a drag on the economy or create inflationary pricing pressures.
But Atlanta Fed President Jack Guynn soothed oil-related inflation speculation saying that we "need to get used to higher energy prices."
Evidence that the economy is going strong has not completely dampened hopes that the Fed will end its rate-hike campaign. The central bank raised the fed funds rate by a quarter-point 13 straight times since June 2004, bringing the rate to 4.25%.
Fed funds futures show that the market is nearly 100% certain that the Fed will raise the overnight lending rate in January to 4.5% from the current 4.25%. But there is only a 56% chance for a move to 4.75% priced in for the following meeting in March.
Moreover, the January Philadelphia Fed manufacturing index fell to a nearly flat 3.3, vs. expectations for a rise to 13, and showed declines in prices paid and received.
But beyond the headline number, the new orders and shipments components nearly doubled and the employment index also showed a gain.
And December housing starts fell a stronger than expected 8.9% to 1.933 million, vs. expectations for starts to come in at 2.035 million. The November number was also downwardly revised to 2.121 million from 2.123 million, showing more evidence that the sector is slowing.
Some economists worry that slowdown in housing could give way to a soft economy, since U.S. consumers have used their rapidly rising home equity to, among other things, boost their purchasing power.
But Anthony Crescenzi, chief bond market strategist at Miller Tabak and RealMoney.com contributor, argues that a housing slowdown could actually boost inflation, because more people will rent, rather than buy homes.
Even though the December core consumer price index number, which factors out food and energy costs, came in Wednesday at a relatively tame 0.2%, he points out that the gain was led by a 0.3% gain in the component known as owners equivalent rent, which represents 23% of the overall CPI.
This was the largest gain since last May and above the monthly trend of increases of 0.2% per month.