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Bonds Attempt Gains but Are Denied

Today brought more evidence that the bond market is running out of steam. Not even Russian devaluation could push up the long bond, which realized gains early in the morning but traded weakly into the afternoon as U.S. stocks recovered.

The 30-year Treasury bond, which briefly touched 5.51% overnight, finished the day virtually unchanged at 5.55%. The price of the bond tailed off gains of 9/32 and was down 2/32 to 99 9/32 as of 6 p.m. EDT.

The question after today's action: Where can this market go? The tenuous financial situations in Russia and Japan -- politically and economically the two most significant nations to the U.S. -- cannot get much worse. Nor can our economy improve much on its performance.

"Why should we be optimistic on lower bond yields when we couldn't get them today?" said Robert Brusca, chief economist at

Nikko Securities

. "It's a little bit hard to imagine that over the next year bonds are going to outperform stocks unless they do it if the stock market falls."

The 30-year Treasury bond is still trading at historical lows, just above the federal funds lending rate, indicating comfort with long-term liquid assets and hope that the


would consider an ease. Either the reaction to Russia today was a sober realization that U.S. Treasury bonds cannot make much more in the way of gains on flight-to-quality or it was a move prompted by equity recovery.

It was more likely the latter. According to

Stone & McCarthy Associates

, money-market investors are decidedly bullish on the safe and liquid -- U.S. Treasuries. Domestic stocks opened down but recovered, taking the juice out of Treasuries going into the evening. Whereas the daily travails of various emerging markets helped bonds rally during the last year, these have only temporary effects now. Russia devalued and the affects were short-lived.

Assuming Russia works on resolving some of its economic difficulties, it will receive help from the


because that is in the political interests of the world's powers. Other foreign problems persist. Japan has not moved quickly enough to sate the market's desire for the quick hatching of a restructuring plan, and risk of devaluation remains in China.

"I think we need new information on the domestic economy," Brusca said. "There's been so much flight to quality trading you have to wonder how much is left."

Furor in the capital markets born of watching Japan, China and Russia in the last month has rendered tomorrow's

Federal Open Market Committee

meeting practically meaningless.

While July's meeting attracted great attention as to the possibility of a Fed tightening, this time it is generally believed that the Fed is unlikely to move, although there is speculation that the restraining bias adopted in March may be rescinded.

"We're in a timeframe that has no precedent," said Kevin Flanagan, first vice president and money-market economist at

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Morgan Stanley Dean Witter

. "If the Fed were to be truly neutral and not biased towards restrained you could make a case for rates heading 10 to 15 basis points lower."

But this would require at least some comments by a Fed official leaning toward that. Anthony Crescenzi, chief bond market strategist at

Miller Tabak Hirsch

, said despite the global pressures, without validation by the Fed, trading in this territory cannot be sustained.

"This is not something that the market takes lightly, as it as happened only three times in the last seven years," said Crescenzi, who views a cut as unlikely. "The market must have a feeling that a rate cut is coming."

Fed Chairman

Alan Greenspan

was able to squelch hopes for a rate ease during his


testimony last month by focusing his speech on the tight labor markets. A move by him now would be surprising for the cautious Fed chair, not one to quickly pull the trigger on monetary policy.

"That kind of logic flies in the face of employment rate viewed by the Fed as incredibly low," said Brusca. "You don't drop interest rates because you think a foreign country needs it."

What would enhance that chance is further weakness in U.S. stocks, perhaps pushed by global stocks. The


is near the January 1998 low of 14,456 and was down 329 points, or 2.18%, yesterday. China's

Shanghai Composite

finished its overnight session down 8.36% to 1070.41 and Russia's

Moscow Times

was down 7.66% to 208.25.

"Nontraditional players are pushing yields lower than they otherwise would be," Crescenzi said. "The swing players would be the first to sell if they felt the equity market in the global picture had changed. They'd probably sell bonds fast."

Expectations as reported by Reuters