Treasuries Cheapen, Bracing for the PPI

But bond prices have dropped so much this week that some expect a rally if the numbers are only as strong as forecast.
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PPI

, the bond market is ready for you. Probably.

Treasuries eventually pared the losses they sustained this morning when the September

retail sales

report printed stronger than expected, but only slightly. Yields settled at the highest levels seen this year, also because of the possibility that the September Producer Price Index slated for release tomorrow morning will rise strongly, prompting the

Fed

to hike interest rates again next month.

The benchmark 30-year bond ended the day 20/32 lower at 97 11/32, lifting its yield 4 basis points to 6.32%, the highest since Oct. 21, 1997. Shorter-maturity note yields tacked on anywhere from 5 to 6 basis points, also reaching their highest levels in nearly two years.

The vital question is whether the massive losses Treasuries have suffered this week mean that if the PPI is in line with expectations, Treasuries won't flinch, and might even rally. More than a few people think so.

The PPI, which measures inflation at the wholesale level, is forecast to rise 0.5% overall and 0.4% at its core, which excludes food and energy prices. Increases of that size would match or beat the largest increases of the year, and are expected because oil and tobacco prices rose sharply in September. Bond traders' fear that broad-based price increases will push the indices even higher than the average forecast. "The key question is what it's like outside of special factors,"

Morgan Stanley Dean Witter

chief U.S. economist Richard Berner said.

And so, unless the PPI blows the consensus forecast out of the water, the Treasury market may see some positive action for the first time in over a week, some say.

If the PPI rises 0.5% overall and 0.4% at its core, Matt Frymier, a note trader at

Banc of America Securities

in San Francisco, said, "I don't think

the market would go down. If anything it would go up."

Frymier said the Treasury market pared its losses this afternoon because the PPI "has surprised more people by coming in lower than by coming in higher over the last two years." Considering how far prices have fallen this week, "it's hard to stay short for it," he added.

Berner agrees that as-expected PPI numbers shouldn't rattle the market, and might even give it a lift. But in the longer term, the Treasury market is still under a cloud, he says.

"People are continually hoping that the next Fed tightening is the last one, or that the next move up in bond yields is the last one," Berner said. That won't happen, he said, without better-than-expected inflation numbers, an economic slowdown, or a sharper decline in the stock market. "How much longer can the stock market resist higher yields is the question everyone wants to know the answer to," he said.

"There's no good reason to buy the market," Frymier concurred. "Until people have a reason to buy it, they're going to be negative on it. That's been the case not only all week but all year."

Bonds sank today after September retail sales of everything except autos rose 0.6%, twice as much as expected. Overall sales rose 0.1%, vs. an average forecast that they'd be unchanged.

Retail sales were the main event, but simultaneously it was reported that the weekly count of

initial jobless claims

sank back to 285,000 from 300,000, and the

Import Price Index

rose 0.7%.

To the Treasury market, it was a sickening sight: Strong consumer spending, attended by mini-reminders of the tight labor market and rising prices.