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Disinversion in Treasuries Continues Despite Economic News

Is there an interest-rate cut on the horizon? Some bond investors appear to think so.

An early rally in the bond market after a surprisingly friendly reading on inflation at the wholesale level morphed into a selloff that moved the 30-year bond's yield decisively higher than the 10-year note's yield for the first time since January, amid shifting views on monetary policy and heavy issuance of corporate bonds.

While there was no specific reason for investors to embrace the view that a slowing economy may prompt the

Fed to cut interest rates, bond market action that lifts long-term yields relative to short-term yields traditionally signals that that's what they are doing.

Interest-rate cuts are inflationary, and expectations of higher inflation lead investors to demand higher long-term interest rates. The recent rise in oil prices has also fanned fears that inflation could accelerate.

The benchmark 10-year Treasury note, which traded up as much as 7/32 early in the session, ended down 15/32 at 99 21/32, lifting its yield 6.2 basis points to 5.793%. Shorter-maturity issues fared better, their yields rising by smaller increments.

The 30-year bond, however, sank 1 8/32 to 106 2/32, hiking its yield 8.5 basis points to 5.818%.

Yesterday, the 30-year bond's yield ended the day higher than the 10-year note's for the first time since January. It dropped below the 10-year note's yield as the Fed's interest-rate hikes slowed the economy, and as the Treasury Department reduced the supply of 30-year bonds through reduced issuance and

buybacks.

At the

Chicago Board of Trade

, the December

Treasury futures contract fell 26/32 to 99 4/32.

Key economic data released this morning, ending a week-and-a-half-long data drought, suggested that the Fed should keep the

fed funds rate where it is, bond traders said. "Ironically, the numbers argue for more inversion," said Charles Parkhurst, head of government bond trading at

Salomon Smith Barney

.

August

retail sales

(

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chart |

source

) rose 0.2% (0.3% excluding autos), and while those numbers were in line with expectations, substantial upward revisions to July's numbers put the level of retail sales in August much higher than it otherwise would have been. In other words, consumer spending continues at a healthy clip.

Meanwhile, the

Producer Price Index

(

definition |

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source

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) fell 0.2% in August, vs. an average forecast that it would rise by that amount. A very friendly report on the surface, but the decline was due entirely to food and energy prices. Energy prices have risen sharply since August, suggesting that September inflation reports will be anything but friendly. The core PPI, which excludes food and energy prices, rose 0.1% in August, a tenth less than expected.

Still, Treasuries rallied when the economic news broke. But within half an hour, prices peaked and the selloff started.

Mark Mahoney, Treasury market strategist at

UBS Warburg

, noted that "a huge retail trade" out of 30-year bonds and into five-year notes occurred. "The implication is that the next Fed move is an ease -- that's the only reason you would do that trade," he said.

While the economic data provided no reason to draw that conclusion, it may be rooted in speculation that the sagging euro and its evil twin -- unaffordable energy in Europe -- could prove disastrous for global growth and the earnings of multinational corporations, Mahoney said. "It's as if the economy is unwinding and nobody knows it."

To be sure, the price action was also driven by factors that have little or nothing to do with anyone's point of view about the economy. Corporate bond issuers have been very active this week, selling some $13 billion of new bonds, nearly double the year-to-date weekly average of $7.5 billion. Corporate bond issuance can trigger selling of similar-maturity Treasuries by underwriters, investors, or both, and this week's slate included some 30-year corporate paper. In the 30-year Treasury bond, where liquidity is often poor, large sales can trigger large price changes.

And Stephen Suttmeier, a technical analyst at

MCM Moneywatch

, noted that a key support level was breached in the December Treasury bond futures contract when it traded below 99 9/32, accelerating the decline below that level.

Economic Indicators

In other economic news,

initial jobless claims

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definition |

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source

) rose to 324,000, their highest level since January 1999, from 311,000 the previous week, indicating continued slackening in the labor market and possibly a slowing rate of job growth.

Currency and Commodities

The dollar gained against the yen and fell against the euro. It lately was worth 107.52 yen, up from 107.15. The euro was worth $0.8638, up from $0.8593. For more on currencies, see

TSC's

Currencies column.

Crude oil for October delivery at the

New York Mercantile Exchange

rose to $34.07 a barrel from $33.82.

The

Bridge Commodity Research Bureau Index

fell to 228.84 from 229.78.

Gold for December delivery at the

Comex

fell to $276.50 an ounce from $276.00.