Bond Market Dusts Off the Rally Caps

The strong move in bonds got stronger a day after the Fed hike, with the long yield down to 5.86%.
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Bear market? What bear market?

Feeding off of yesterday's seemingly neutral statement from the

Federal Reserve

, the Treasury market ran roughshod over all challenges to its muscle-flexing rally today. Durable goods? Dead. Weak two-year auction? Dead. Neidermayer?? Dead!

Day two of the post-rate hike rally dropped the yield on the 30-year Treasury bond to its lowest level in three months. Of late, the 30-year Treasury was up 1 5/32 to 103 26/32, dropping the yield 7 basis points to 5.86%.

This closing yield is the best for the bond since May 28, and the force of this rally has surprised some in the market. Not that long ago the bond market was gloomily selling off after a powerful July

employment report

and many were privately, if not publicly, pondering the odds of a 50-basis-point rate hike by the Fed come Aug. 24. The market retreated from that stance with the release of a couple of friendly inflation numbers in the last two weeks, and yesterday's somewhat dovish

statement solidified the market's recent positive tone.

"The market is acting like there's no possibility of the Fed tightening further in here and I think that's stretching it a little bit," said Maryann Hurley, a vice president in trading at

D.A. Davidson

. "Yes, we have a neutral bias, and yes, the statement was friendly, but yes, they are going to watch the data. The Fed believes at this point that the economy is growing above target, and they're hoping that the economy is going to slow down on its own."

If today's

durable goods

report is any indication, it is not happening yet. Durable goods orders rose 3.3% in July, following a revised 0.5% in June. The market was anticipating a 1% increase in orders. This report tends to be volatile from month to month, and businesses were letting inventories run down in the second quarter. Economists anticipate businesses will build up inventory in the third quarter and early in the fourth quarter to guard against Y2K problems, but they aren't sure this is the reason for the huge build-up in orders in July.

Excluding volatile transportation orders, durable orders rose 3.7%, compared with the

Reuters

consensus estimate of a 1.1% increase. The huge increase in July already has economists projecting that GDP could grow by 4% in the third quarter, a growth rate the Fed had previously deemed unsustainable without the economy feeling the effects through wage inflation or price inflation.

"I think the door is still open for further rate increases if the data justify them," said Russ Sheldon, chief economist at

MCM Moneywatch

. "GDP growth is probably expected to bounce to 4%

in the third quarter which doesn't sound consistent with the Fed not moving rates again."

Sheldon believes the market is acting too confident in the wake of the Fed's statement, which does make it seem if the Fed is comfortable with this year's two rate hikes (the first was at the Fed's previous meeting June 30).

"Today's increase in the federal funds rate, together with the policy action in June and the firming of conditions more generally in U.S. financial markets over recent months, should markedly diminish the risk of rising inflation going forward," the statement says. The Fed raised its target on the fed funds rates to 5.25% yesterday, the second 25-basis-point rate hike of the year.

"Obviously, the Fed statement most powerful thing here, and it tends to mitigate secondary economic indicators," said Michael Krauss, chief technical strategist at

Chase Securities

. "Even if

the durable goods number is strong, it may not have same kind of negative effect as we had two months ago."

Krauss added that technical buying in the futures market also added to the rally late, as the September bond contract rose above 116 21/32, a key resistance level for technical buyers.

The

Commerce Department

will release its first revision to second-quarter GDP tomorrow at 8:30 a.m. EDT, originally estimated at 2.3%. Because of the rise in the trade deficit, this figure is expected to be revised downward (consensus forecast is for 1.8%), but that belies the economy's true direction -- the trade deficit is a drag on the economy because consumer demand in the U.S. is feeding increased exports to this country.

The

Treasury Department

sold $15 million in two-year notes this afternoon at a bid-to-cover ratio of 1.87, and traders indicated the auction was somewhat weak.

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