Morning Weakness Creates Buying Opportunity

Bonds closed lower but were well off their earlier losses.
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Those who gave up watching Treasury bonds this morning missed a valiant comeback. Bonds were knocked down in overnight trading and at one point the long bond had lost over 1 1/2 points.

But all ends of the curve rose from the ashes -- and lately the 30-year Treasury bond was down 23/32 to trade at 99 5/32, while the yield rose to 5.31%.

However, the selloff pushed the yield on the 30-year bond as high as 5.37%, where it found support. This was the highest intraday yield reached on the bond since Nov. 6, and buyers came into the market at various points on the yield curve. With the exception of the two-year note, the entire curve is now yielding more than the 4.75% funds rate.

The buying helped prop up the bond market even as the dollar weakened further, falling to 108.80 dollar/yen, a 28-month low. Equities were soft most of the day, and that helped improve the bond's position. Analysts also said the early activity was a delayed reaction to Friday's exceedingly strong

employment

report.

"Bonds were down five of the past six trading days," said William Hornbarger, market strategist at

A.G. Edwards

. "Maybe the market just realizes we're oversold. Rates have backed up so people are nibbling around the edges, thinking this is a good time to buy."

While dollar/yen was again offered -- and rightly so -- as the cause of the decline, analysts said today was also the culmination of changing sentiment that began between four and six weeks ago. Two different articles this weekend by

Market News'

Steven Beckner lent a voice to the theory economists have expressed increasingly in the last month: that the Fed is unlikely to cut rates soon, and a tightening is almost as likely as an easing.

The fed funds futures contracts from the current January contract to the June 1999 contract, traded on the

Chicago Board of Trade

, have shifted into neutral. This process began last month, and now all active contracts are no longer discounting any chance that the

Federal Reserve

will cut interest rates again.

"They went from a pretty clear bias to absolute neutrality, if that's a correct term to use," said Henry Willmore, senior economist at

Barclays Capital

. "The main risk for an ease right now would be additional turbulence in financial markets; stocks are quite overvalued. But the market is not as fearful of systemic risk that was at top of everyone's mind as last year."

Fed Chairman Alan Greenspan reportedly told a group of central bankers in Hong Kong that the U.S. economy will remain sound, though it is expected to slow this year. Several Fed officials in recent speaking engagements have expressed concern about the growth of money supply as well as valuations in the stock market. Some, such as Vice Chair

Alice Rivlin

and Atlanta's

Jack Guynn

, are not strict monetarists as Cleveland's

Jerry Jordan

is. (He dissented hawkishly five times in 1998.) It was apparent last year that a mere 15% to 20% decline in the equity market was not enough to force a shift in monetary policy from the Fed. Liquidity had to dry up in the entire fixed-income sector before the Fed went on the attack.

Tomorrow is a light day for economic data. The Atlanta and Richmond Federal Reserve districts each release their December survey of business conditions. Both of these reports were weak in November.

Lynch, Jones & Ryan

and

BTM/Schroder

release weekly sales figures. December turned out to be a strong month for retail sales, despite weakness in the early part of the month.