Updated from 2:03 p.m. EST
A blowout 30-year bond auction left the yield curve decidedly inverted Thursday, as the long end rallied and rate-hike speculation weighed on the two-year.
The benchmark 10-year note closed up 2/32 of a point to yield 4.54%. The note yielded as much as 4.57% in the morning, when Treasuries got whacked by a strong report on jobless claims.
The 30-year bond jumped 14/32 to yield 4.65%, after losing more than half a point in morning trading. Bond prices and yields move in opposite directions.
The five-year note gained 1/32 of a point to also yield 4.54%. The two-year edged lower 1/32 to yield 4.65%, 11 basis points more than the yield on the 10-year and on par with the 30-year yield.
Longer-dated maturities typically yield more to compensate investors for taking on the additional risk of a longer-term loan, but the 10-year yield fell below every note on the short end. Such an "inverted" yield implies that investors see more risk in the near term and has been used a leading indicator of recession.
"The inversion story will gather more momentum," says John Herrmann, director of economic commentary for Cantor Viewpoint. "What the yield curve is saying is that the cumulative effects of Fed rate hikes should finally have some sort of slowing effect in first half of the year."
But Herrmann says a full-scale recession is not in the cards because there's still a lot of room to tighten rates, making it unlikely that the central bank will overshoot and raise rates too much.
The real fed funds rate, which factors in the effects of inflation, averaged 3.64% over the second half of the 1990s, according to Herrmann. He adds that, in real terms, the fed funds rate is still 100 basis points below that level.
The Treasury's $14 billion 30-year bond sale, the first since 2001, drew a mediocre 2.05 bid-to-cover ratio, meaning that for every $1 of debt on sale there were $2.05 worth of bids. But the average cover for the previous 10 bond auctions has been 2.25.
But the market chose to focus on the enormous 64.4% participation rate of indirect bidders, the category that includes foreign and institutional investors.
Richard Gilhooly, interest rate strategist at BNP Paribas, had predicted that indirect bids needed to come in at a high 50% to 60% to justify claims that there was strong demand for the bond. Sales were suspended in August 2001 to reduce borrowing costs on the heels of four years of federal budget surpluses.
Foreign central banks have played a key role in U.S. debt financing, increasing their share of Treasuries to 52% as of November 2005, up from less than 35% in 2001. Long-term rates have been kept low, fueling sectors including housing and consumer spending.
Fixed-income strategists at Barclays Capital call the bond "a natural hedge vehicle" for institutional investors, and Herrmann adds that scarcity made the bond popular.
The bond also yielded 4.53% at the sale, which completed the government's $48 billion refinancing, which also included a $21 billion three-year note sale Tuesday and a $13 billion 10-year note sale Wednesday.
The refundings are being closely wathced, now that the White House has released its $2.77 trillion budget forecast for next year. This session's $14 billion auction is the largest ever for a 30-year bond.
The uncertainty leading up to today's auction prompted the city of Indianapolis to postpone its $78 million debt issuance also scheduled for today.
"We originally contemplated going this week. Now we want to see how interest rates react to the new 30-year bonds," an executive at Indianapolis Bond Bank told
Other entities that want to sell longer-maturity debt may also wait for California's $1 billion issue to hit in March, as it could set the pricing tone for subsequent auctions.
Treasuries fell in morning trading after jobless claims for the week ended Feb. 4 came in at a very low 277,000, up just 4,000 from the previous week. The report from the Labor Department marks the fourth straight week that claims have come in below 300,000.
The four-week average also fell to 277,000, the lowest since April 2000, more support for the idea that the labor market is strengthening.
policymakers have spent months saying that they are carefully monitoring the employment picture because the U.S. is close to "full employment," or the lowest level of unemployment possible before wage inflation sets in. Bond traders loathe inflation because it erodes the value of fixed-income investments.
Fed funds futures have priced in near-certain odds that the overnight lending rate will go to 4.75% in March and a 70% chance that the rate will hit 5% in May, up from 56% odds in the previous session, according to data from RBS Greenwich Capital.
In other economic news, December wholesale inventories and sales both rose a stronger-than-expected 1.0%, leaving the monthly inventory-to-sales ratio unchanged at 1.15, near October's record low of 1.14 months.
And Federal Reserve President Michael Moskow says that he sees little slack in the labor market and that the low jobless rate may put upward pressure on wages.
In prepared remarks delivered this afternoon to the Chicago Chapter of the Risk Management Association, he adds that "neutral" does not necessarily mean that the days of rate hikes are done.
His comments come a week before Ben Bernanke's first appearance as Fed chief, presenting the semi-annual monetary policy report to Congress.
Some of Bernanke's thunder may have been stolen by recently retired central bank top dog Alan Greenspan, who was reportedly
out and about spreading the gospel of a strong economy and fueling the twin fears of inflation and rate hikes.
The markets have underestimated the amount of monetary tightening yet to come and low long-term interest rates have hampered the central bank's ability to direct the economy, he allegedly said Tuesday during a private dinner for Lehman Brothers clients.
Whether the reports distort what Greenspan actually said, they're in line with comments he made while at the helm of the Fed and are nothing that should really move the market, notes Jim Glassman, chief economist at J.P. Morgan.
Private citizen Greenspan's alleged comments have put more pressure on Bernanke to take a tough stand on inflation.