Low Financing Rates Lift Treasury Prices

The Fed's efforts to make sure the banking system has enough cash for Y2K are also making it very profitable to own bonds.
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Bond prices are modestly higher again today, driven up by the fact the


, through

open market operations

, has made it extremely cheap for institutions to finance their ownership of Treasuries.

The move brings yields to their lowest levels in two weeks. The benchmark 30-year Treasury bond lately was up 6/32 at 96, trimming its yield a basis point to 6.43%, a level it hasn't closed below since Dec. 17. Shorter-maturity notes, which are more liquid and thus in higher demand than the bond, are faring even better. Their yields are 2 to 3 basis points lower on the day.

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A shift in the fundamental outlook for Treasuries, which have been beaten up amid worry that strong economic growth will force the Fed to hike the

fed funds rate

at least once next year? Hardly, said Matt Frymier, a trader at

Banc of America Securities

in San Francisco.

"It's all repo. That's all that's going on," he said. "The Fed has injected a ton of money into the system, so everybody's trying to loan their money. Everybody wants to loan money, and borrow securities." As a result, he said, "securities are hard to come by, so people who are short are getting tortured. They're trying to buy stuff back so they won't have to eat the carry on it."

Translation: To supply the banking system with enough liquidity that anyone who wants to withdraw a large sum of cash over the turn of the year can do it, the Fed has been buying vast quantities of debt securities from dealers, with agreements to sell them back after Jan. 1.

These operations have swollen the system's liquidity so much that short-term lending rates have fallen sharply. For example, while the Fed's target for the fed funds rate is 5.5%, the actual fed funds rate lately was 4.25%. Overnight repo rates -- the rates that traders pay to borrow the money they need to finance their purchases of Treasuries -- are even lower, in the neighborhood of 2%.

A large spread between the interest rates on Treasuries and the cost of financing them makes it highly profitable to own Treasuries -- and highly unprofitable to be short.

There were a few economic releases this morning, but traders paid them little mind.

Initial jobless claims

dropped to 274,000 from a revised 283,000 the previous week. That indicates tightness in the labor market, but less than existed two weeks ago, when only 267,000 initial claims were filed, a generational low.

Also, the

Chicago Purchasing Managers' Index

, a measure of strength in Midwest manufacturing that indicates growth when over 50, eased to 54.6 in December from 56.8 in November.