Bonds Retreat Ahead of CPI

Bonds retreated for the first time in five sessions Wednesday for no clear reason. Market participants described the day's action in mostly technical terms, although some expressed concern about a negative surprise by the February

Consumer Price Index

, due out tomorrow morning.

Surprises in the day's only major economic release, the Fed's

Beige Book

, were few and mild. And continuing a trend that started with the release of the February

employment report

a week and a half ago, volume remained well below average. It was 39.8% below average for a first-quarter Wednesday at 3 p.m. EST, with $47.1 billion of Treasuries having changed hands, according to tracker

GovPX

.

The benchmark 30-year Treasury ended the day down 12/32 at 96 10/32, lifting its yield 3 basis points to 5.51%. Shorter-maturity note yields rose by similar amounts.

Treasuries gained overnight as the dollar retraced some of its recent losses against the Japanese yen. A stronger dollar boosts Treasuries because it is anti-inflationary, and because it enhances their appeal to foreign investors. The dollar, which dropped for nine consecutive sessions after peaking at 123.39 yen on March 4, landing at 117.70 on Monday, rallied to 118.11 today after a Japanese official said he thought the yen's recent rally was "a little excessive." Haruhiko Kuroda, director general of the

Finance Ministry's

international bureau, made the comment to reporters in Tokyo.

The long bond gained as much as 15/32 shortly before 8:30 a.m. EST, but soon relinquished those gains and closed near its lows of the day.

"One should not read too much into it," said Avram Altaras, Treasury market strategist at

Bear Stearns

. "There was buying in Japan so the market rose, but then there was no follow-through, so some people took the opportunity to sell."

The technical aspect of the day's move was that the Treasury bond futures contract traded on the

Chicago Board of Trade

failed to rise above 122 23/32, a key resistance level. In the jargon of technical analysts, that price represents a 38.2% retracement of the January-to-March decline in the Treasury market. Failure to rise above it is considered a bad sign.

But the move was not without a fundamental basis, in the view of Mark Mahoney, Treasury market strategist at

Warburg Dillon Read

. "The market doesn't have much value to begin with," he said. "We keep getting stronger-than-expected economic news and the market just keeps going up. The drift lower makes sense to me."

Mahoney also sees considerable risk to the market from the February CPI report. Economists surveyed by

Reuters

expect a 0.1% increase overall and a 0.2% increase in the core CPI, which excludes volatile food and energy prices. But Mahoney thinks a big increase in housing costs, which have been remarkably tame for the last two months, could drive up the core by as much as 0.3%, triggering a bond-market selloff.

"Inflation is the biggest risk to the market," he said. More good news on inflation has less potential to lift bond prices, in his view, than a negative surprise does to whack them. "There's not a lot of room for the market to go up, but there's plenty of room for it to fall."

Or maybe not.

They're certainly singing a different tune over at

Lehman Brothers

. Notwithstanding the possibility of a fluky CPI number, senior economist Ethan Harris isn't worried about the long-term prospects for inflation. According to his view, bonds are cheap.

"There's a group of investors out there who are waiting for inflation to take off at any point, mainly because they're concerned about the strong growth figures we've been seeing," he said. "Our view is that they are ignoring fundamental changes going on in the productive capacity of the economy which make it possible to grow very rapidly without generating inflation."

Rather than growth threatening to heat up inflation, low inflation thanks to new technologies and international competition is driving growth by encouraging consumer spending, Harris says.

"We think the scare is coming to an end in bonds," he said. "As the market comes around to the view that strong growth is not going to generate inflation, fears about the

Fed

will recede and the long bond yield will head back toward 5%."

As for the

Beige Book, which the Fed's monetary policy committee will consider at its March 30 meeting, it once again described a strong economy attended by both tight labor markets and low inflation. But in a departure from the trend of the last year or so, it said that manufacturing activity expanded in most regions.