Bonds Suffer Through a First Millennium-Style Torture Session

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Meet the new boss ... same as the old boss.

The Treasury market began 2000 about as well as it ended 1999, with a 15 basis-point plunge that dropped bond yields to their worst levels in more than two years. And with the exception of the

National Association of Purchasing Management's

manufacturing

index, the market accomplished this without any news releases at all.

No, strategists today attributed the rapid decline to the fear of more

Federal Reserve

interest rate hikes. Before the Y2K date change, the market could at least hold onto the fading hope that slight disruptions would cut into economic growth in the first quarter, but computer disruptions so far seem to be more inconsequential than expected.

"It's only the first day of January, but till now we haven't heard of any disruptions," said Kathleen Camilli, director of economic research at

Tucker Anthony

. "But the market today is worried that there's absolutely no Y2K problems, so the economy is going to continue to barrel along, and cause multiple Fed tightening."

Lately the 30-year Treasury bond was down 1 25/32 to 93 19/32, right near its worst levels of the day. The yield rose 16 basis points to 6.62%, highest since Sept. 11, 1997.

The market collapsed almost instantly. With both U.K. and Japanese markets closed, put this one all on fear of Fed. Treasuries were down as much as 1 15/32 early, prodded along by a strong morning rally in the stock market. As the equity markets stumbled, with most eventually finishing down on the day, the market recovered, but gave back those gains in the late afternoon to finish at the lows of the day.

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From a technical point of view, the market busted through identified support levels around 6.53% and was not far off another support level of 6.66%, according to Michael Krauss, chief technical strategist at

Chase Securities

.

"It's still a market in a weak position," said Krauss. "We closed the year on a sour note. We had 11 straight down months in bond futures, and there's the increased feeling that the Fed may need to become aggressive on the tightening side."

The market is not only acknowledging one rate hike, but virtually betting on two interest-rate increases as well.

Many in the market think the Fed would have raised rates on Dec. 21, but wanted to stay out of Y2K's way before tightening credit. The Fed carefully went about the business of ensuring that banks had enough liquidity to protect themselves from a possible run on automated teller machines at the end of the year and didn't want to scare the market by raising rates so close to the end of the year.

The Fed's Dec. 21

statement made that clear, warning: "the Committee remains concerned with the possibility that over time increases in demand will continue to exceed the growth in potential supply, even after taking account of the remarkable rise in productivity growth."

The

fed funds futures

contract listed on the

Chicago Board of Trade

is already fully pricing in a 25-basis-point hike in the fed funds rate to 5.75% at the Fed's Feb. 1-2 meeting. It's also pricing in a 66.6% probability of a 50-basis-point hike, compared with 62.3% Friday. Two-year notes are currently yielding 6.40%, highest since April 1997.

"Unless the data suggests they have to do more, the bond is OK here at these levels," said Josh Feinman, chief economist at

Deutsche Asset Management

. "Two-year notes are at 6 3/8%; they could live here if the market felt the Fed stops at 6%."

Camilli acknowledged that it's early, but said she was anticipating some disruptions, chiefly in the manufacturing sector, "from suppliers in the third world. If it's taking place, we don't know about it yet."

December's manufacturing activity was strong, even as the overall NAPM index dipped slightly from November. The NAPM, a survey of manufacturing conditions around the country, clocked in at 55.5 in December, compared with expectations for a 56.1 reading, according to

Reuters

. In November, the index read 56.2. A reading greater than 50 indicates expansion in the manufacturing sector; less than 50 indicates contraction.

But by the time this report was released at 10 a.m. EST, the damage was done.