Bonds Little Changed, But Stock Rally Is Spreading Worry

Recent strength in cyclicals and Asian bourses as well as hints from the Fed set a bearish tone.
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Treasuries are little changed this morning on very little news. With no economic releases scheduled, traders are watching the big rally in stocks, and fretting that it fits into a picture of a global economy firmly on the rebound.

The benchmark 30-year Treasury bond was lately unchanged at 95 11/32, its yield 5.57%. It spent much of the morning under water, however, and shorter-maturity note prices were unchanged to lower on the day.

"The rally in stocks here and abroad is clearly weighing on things," said Tony Crescenzi, chief bond market strategist at

Miller Tabak Hirsch

. Indices in Hong Kong and Thailand rose about 10% last week, and Indonesia's index rose about 20%, he noted. Moves like that suggest "it's getting less and less likely that the global crisis will reemerge, and that's taking any chance of a flight-to-quality bid with it," Crescenzi said.

Brazil's plan to sell $1 billion of eurobonds this week is bolstering the sense that emerging markets are back in the game.

As for domestic stocks, the fact that cyclical stocks have become the leaders of the rally in the last week deepens the extent to which rising stock pricing are bearish for bonds, Crescenzi says. "Implicit in the cyclicals' rally is the expectation of more pricing power later this year. Typically the stocks rally first, and then the commodity indexes follow."

Add to that, the strategist says, the fact that recent speeches by

Fed

officials suggest a shift in thinking at the central bank, from viewing the risks to the U.S. economy as balanced between slower growth and higher inflation to viewing inflation as the greater risk, and you've got the makings of a depressed bond market.

Fed Governor Laurence Meyer

,

San Francisco Fed President Robert Parry

and

St. Louis Fed President William Poole

all dropped hints to that effect last week.

Bond traders may also be upset about this morning's

daily report from the

Chicago Mercantile Exchange

on volume and open interest. The report shows a roughly 42,000 increase in open interest in the eurodollar futures contract. On Friday, traders were buzzing about a local trader having sold about that number of contracts, but it wasn't known whether he was closing out a long position or initiating a short position. The open interest report suggests he was doing the latter. Eurodollar futures are a more liquid proxy for U.S. short-term interest rates, so a short position in eurodollar futures is a bet that U.S. short-term rates will rise, led by a rate hike by the Fed. Someone has made that bet in a big way.