Fed's Bias Triggers Tantrum in Treasuries

An inclination to raise rates in November if the economic data warrant it was the minority expectation.
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The bond market failed to get exactly what it wanted from the


today, and so it pitched a fit that sent yields rocketing back toward their highs for the year.

The Fed's monetary policy panel, the

Federal Open Market Committee

, decided as expected to leave the fed funds rate unchanged at 5.25%. It

said that even though the labor market remains tight, rising productivity continues to prevent inflationary consequences.

But most market analysts also expected the FOMC to keep its so-called policy directive neutral. A neutral policy directive indicates that the committee does not currently foresee changing interest rates.

Instead, the committee shifted to a tightening directive, signifying a stronger likelihood that it will hike rates next time it meets, on Nov. 16.

In its statement announcing the decision, the FOMC took care to point out that the tightening bias doesn't mean a November rate hike is baked in the cake. "Committee members emphasized that such a directive did not signify a commitment to near-term action," the statement said. "The Committee will need to evaluate additional information on the balance of aggregate supply and demand and conditions in the financial markets."

But the fact remains that the market was priced for a retention of the neutral bias, and so it had to be repriced. A


poll of the 30 primary dealers of Treasury securities found that 17 expected a neutral bias and 13 expected a tightening bias. In the correction, the 30-year Treasury lost 1 9/32 to 99 7/32, lifting its yield 9 basis points to 6.18%, its highest close since Aug. 12 and just 8 basis points shy of its high for the year. Shorter-maturity note yields, more closely tied to the short-term fed funds rate, fared even worse, rising anywhere from 9 to 13 basis points.

"Not enough people were expecting the change in bias, I guess,"

Warburg Dillon Read

Treasury market strategist Mark Mahoney said.

It isn't clear why not,

Miller Tabak Hirsch

chief bond market strategist Tony Crescenzi said. Historically the Fed, when in a tightening phase, has adopted a tightening bias at meetings where it hasn't tightened. But, he said: "Many people believe that the Fed's new way of announcing the bias has changed the rules of the game." The Fed started announcing bias changes in May.

A portion of the long bond's fall was technical in nature. The bond futures contrast listed on the

Chicago Board of Trade

traded below its intraday low for the year at 112 16/32, which triggered automatic selling that took it down an additional 6/32 before it settled at 112 14/32, down a full point.

Helping set the tone for the bond market's fall, gold continued its meteoric rise, reaching $324 today, its highest close since October 1997, from $317 yesterday.

Whether the FOMC ultimately hikes in November depends on how strong the economic data are between now and then, market participants said, especially the

employment report

for September and October, and the core



Consumer Price Indices


"We're on vigilant watch," Mahoney said. "Every number is going to be dissected to see if they go in November."

Dennis Gartman, publisher of

The Gartman Letter

, suggested that the FOMC may have adopted a tightening bias because its members have already had a peek at the September jobs report, slated for release on Friday, and it is strong. In that case, he said, the weight shifts to the September PPI and CPI, to be released mid-month, and to the October jobs report.

"But for Y2K, there's no question they would have moved to tighten," Gartman said. "They are praying for some slowdown in the numbers that will allow them not to tighten before the end of the year."

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