Strong Data Whack Treasuries

The 10-year yield breaches 4.50% as traders weigh the possibility of more interest rate hikes.
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Updated from 10:18 a.m. EST

Treasuries sank Thursday as the market priced in a chance that the

Federal Reserve

has at least two more rate hikes up its sleeve and investors braced themselves for a week of potentially bearish events.

Wall Street widely expects the Fed to raise the overnight lending rate to 4.50% at its Jan. 31 meeting, and fed fund futures show that the market has now fully priced in a rise to 4.75% by mid-2006.

The benchmark 10-year closed down 9/32 to yield 4.51%, up from 4.48% late Wednesday, marking the first time the yield has risen above 4.50% since mid-December. The 4.50% mark is considered a key technical level, or a place where buy orders have clustered, and a significant break out from that range could mean that yields could soar.

The 30-year bond was down 20/32 to yield 4.69%, up from 4.66% the previous session. Bond prices and yields move in opposite directions.

In shorter maturity debt, the five-year was down 4/32 to yield 4.43%, while the two-year lost one tick to yield 4.47%. The three-month bill was yielding 4.43%.

An influential research firm also said Wednesday that the policy statement to be released with the widely expected Jan. 31 rate hike could say that the central bank wants more money tightening.

"On balance, the

Federal Open Market Committee's post-meeting communique is likely to signal further policy firming, that a 25-basis-point hike to bring fed funds to 4.75% in March may be needed before it can safely indicate a likely end to the current rate hiking cycle," read the report by Medley Global Advisors, according to

Reuters

.

A pair of morning economic releases showed greater-than-expected economic strength and worried inflation hawks, including a report from the Labor Department that initial claims for unemployment benefits rose by 11,000 to 283,000 in the week ending Jan. 21, below expectations for a rise to 300,000. This left the four-week moving average at 289,000, the lowest since July 2000.

And December durable goods orders rose 1.3% vs. estimates for a 1% gain, while the November figure was revised to a stronger 5.4%, the Commerce Department reported. Nontransportation orders rose 0.9% and a decline in November was revised to a 0.6% gain.

The rise in overall orders leaves capital goods orders up 29% year-on-year and nondefense capital goods orders, which includes business investment, up 34% on the year.

The reports have also moved some Wall Street prognosticators to up their fourth-quarter GDP forecast. But RBS Greenwich Capital's chief economist Stephen Stanley still believes that Friday's release will show that GDP rose by 2.8% for the quarter, in line with consensus estimates.

Thursday's falling prices helped steepen the yield curve, which Peter Cardillo, chief market analyst with SW Bach & Co., calls a positive event.

"It shows that people are not worried about the economy falling off a cliff," Cardillo says.

The yield curve has been flat or even inverted in recent weeks. The curve usually shows that yields on longer-dated Treasuries are higher than yields on shorter-dated debt, since investors normally want to be compensated for the additional risk of lending money for a longer period of time.

When yields on the short end are on par with or higher than those on the long end, it could mean that investors see more risk in the near term, a perception that has historically preceded an economic slowdown or recession.

But Cardillo thinks that the Fed will raise rates at the Jan. 31 meeting and then pause.

"There's always a threat that higher oil prices could mean inflation, but at these levels they could also slow economic conditions and cut into consumer spending," he says. "Corporate earnings haven't been bad," he adds, "but Corporate America has been cautious."

Matthew Smith, vice president with Smith Affiliated Capital, agrees that the Fed could pause after January, despite the fact that the market is pricing in more hikes.

Smith says that recent economic growth and consumer spending boom were closely tied to the housing market, and that recent sector reports show that this source of capital is disappearing.

"Things will slow down for industries that benefited from the housing boom and consumers who got money out of the refinance market," says Smith. "This will have a lagging impact on the economy, but it the Fed has to take it into account."

Upcoming events that could further weigh on prices include the release of the PCE, which is one of the Fed's favorite inflation measures. Even if it posts another modest 0.2% gain for December, that would bring the annual rate to 1.9%.

RBS Greenwich Capital's bond strategist, David Ader, says that in this bearish environment, 1.9% could be too close to the Fed's upper limit on inflation growth for the market's comfort, with 2% being the central bank's upper limit.

New home sales figures will also come out Friday, and will hopefully help clarify the housing market picture.

The Treasury will also announce Feb. 1 just how large the refinancing will be, which will include sales of three- and 10-year notes and 30-year bonds.

Wall Street estimates that the debt could total $48 billion, and that prices will fall as investors reshuffle their portfolios to make room for the flood of debt.

And next week's series of economic reports includes , data on personal income and spending, the quarterly employment cost index, a handful of manufacturing reports and the January payrolls report.