Bonds Finish Higher, Awaiting Tomorrow's FOMC Decision

Treasuries rebounded modestly from yesterday's selloff even though the NAPM's prices-paid index jumped.
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Treasuries galloped back today after sagging in Monday trading, rising in what strategists described as a position-building session ahead of the results of the Federal Open Market Committee's two-day meeting, which began today.

After a mild selloff following the release of the strong

Purchasing Managers' Index

, the market regained its footing. The PMI showed its highest reading for its prices paid component in almost five years.

The 30-year Treasury was lately up 21/32 to 95 29/32. The yield fell 5 basis points to 6.436%. The 10-year note was up 10/32 to 6.62%. The five-year note, up 2/32, still has the highest yield on the Treasury yield curve, at 6.669%, and the two-year note was up 1/32 to 6.596%. A rally in European bond markets also contributed to the upswing, according to sources.

All 30 primary dealers polled by

Reuters

are expecting a 25-point hike in the

fed funds rate

tomorrow, to 5.75%.

"The market is preparing for a relief trade," said Tony Crescenzi, chief fixed income strategist at

Miller Tabak

. "They feel the Fed is going to go 25, and there could be a trade higher. It could catch some people short." Today's strength was somewhat typical of a market readying itself for a Fed meeting -- particularly after it overreacted in the weeks leading to the meeting on jitters over a potential 50-basis-point hike. Realism having asserted itself, its now regarded as a very slim possibility. Mike McGlone, vice president at

Aubrey G. Lanston

, said the market isn't ready for 50 basis points.

After tomorrow's meeting, it may have to start weighing the possibility that the Fed may get more aggressive, if historical patterns regarding the

National Association of Purchasing Management's

index hold true.

The PMI fell to 56.3 in January from a revised 56.8 reading in December. However, the prices-paid component, which measures what manufacturers are paying for goods used in production, soared to 72.6 in January from 68.3 in December. The survey shows price inflation is emerging in manufacturers' production costs.

This is the highest reading for the price-paid index since April 1995, when the index hit 74.5. In 1994, the index surpassed 70, and late 1994 the prices-paid index breached 80 four straight times, coinciding with an aggressive round of Fed tightening. The same happened in 1988, according to David Orr, chief capital markets economist at

First Union

.

"This adds to the likelihood that in March we'll follow with another

Fed increase," said Orr.

The NAPM index indicates expansion when above 50 and contraction when below 50.

Fed officials, in comments, have warned of impending hikes, but they've been careful to intimate that the committee's approach will probably be gradual, to avoid destabilizing the markets. (

TSC

previewed the Fed meeting in a

story earlier today.)

Speculators Way Short

However, some may be thrown off course if the Fed hikes just 25 basis points, and traders will be there to take advantage. The

Chicago Board of Trade's

Jan. 25

Commitments of Traders

report shows a record short position among speculators in the bond market, who are historically lousy at timing the market. According to the report, provided by the

Commodity Futures Trading Commission

, noncommercial traders are net short 71,094 contracts, an all-time high, compared with 61,020 for the week ended Jan. 18.

The CFTC measures exposure to futures by hedgers (also active in the bond market and use futures to hedge their risk) and speculators (not active in the bond market and who absorb risk from hedgers). If the speculators are forced to cover their short positions, it would compound a relief rally.

"Many are taking that report seriously," said Crescenzi. "It's the type of information that leads people to think that there's going to be more short-covering if Fed does just 25. Last time it hit a record in

October, the market followed with a 5-point rally."

European bond markets rallied overnight due to a decline in the

Reuters

Eurozone PMI, its version of the

Purchasing Managers' Index

, which was down in January to 55.6 from 57.7 in December. The yield on 10-year German Bunds fell to 5.46% from 5.52% yesterday. The yield on 10-year British gilts dropped to 5.59% from 5.72%.

The

Senate Banking Committee

approved the renomination of

Fed

Chairman

Alan Greenspan

, sending it on to the full Senate for confirmation Thursday.

Traders are also looking forward to tomorrow's refunding announcement. The

Treasury Department

will announce details of its quarterly refunding auction, which will include the sale of five-year, 10-year and 30-year Treasuries the second week of February.

Economic Indicators

The 72.6 reading for the prices-paid component marked the fifth consecutive month the prices-paid index has been over 60, and the ninth month in a row over 50. In January, 42% of purchasing executives reported paying higher prices and 5% reported paying lower prices, according to NAPM's

release.

Multiple components of the index, however, declined in January, including employment, supplier deliveries, exports and imports.

Construction spending

increased 2% for the month of December, according to the

Census Bureau

. Economists as polled by

Reuters

were expecting no change. The value of construction put in place increased to a seasonally adjusted annual rate of $730.3 billion in December, up from a revised $716 billion in November. November's 2% gain was a downward revision from an original 2.6% gain.

The

BTM/Schroder

weekly chain store sales report was down 0.2% for last week, after a 1% increase the previous week. The

Redbook Retail

average was revised down to a 1.6% gain in sales for the month through Sunday, vs. December, compared with 1.7% last week.

Currencies and Commodities

The bond market was supported by the recent rise in the dollar against the yen, lately at 107.79 from 107.40 yesterday. The dollar fell against the euro, with the euro recently at $0.9725 from $0.9693 yesterday.

Crude oil for March delivery at the

New York Mercantile Exchange

rose to $28.30 a barrel from $27.64 yesterday.

The

Bridge Commodity Research Bureau Index

fell to 209.71 from 201.46 yesterday.

Gold for April delivery at the

Comex

was lately down, at 285.4 from 286.2 yesterday.