Treasuries Continue to Drag Their Feet

The yield curve's flattening, suggesting expectations of a rate hike.
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Talk about kicking a guy when he's down. The market was still smarting from yesterday's surprising 1.1% jump in the

Employment Cost Index

when two more unfriendly economic releases appeared this morning. Bonds were also suffering from the continued weakness in the dollar, as investors have regained confidence in the prospects for other economies.

Two important monthly releases, the July

Chicago Purchasing Managers Index

and June

new home sales

, again reminded the market that the economy is strong, everybody is spending money and business is booming. But bonds were in a bad mood before that, having lost about one-half point even before these 10 a.m. releases. The 30-year Treasury bond was lately down 18/32 to 88 7/32. The yield rose by 4 basis points to 6.11%, its highest level since June 26.

"It's left over from yesterday," said John Blough, senior investment strategist at

Fahnestock & Co.

"The ECI was very negative, and bonds are in a defensive posture. I would now think it's pretty close to a 100% chance

the

Federal Reserve

will tighten in August."

Today's releases don't counteract that line of thinking. The Chicago PMI, a measure of business sentiment in the Midwest manufacturing sector, rose to 60.5 in July, the third straight reading above 60. A reading above 50 indicates growth in the sector, and before April this index had not hit 60 since August 1997, just before the free fall in Asian markets cut off demand for manufactured products.

Sales of new homes rose to 929,000 on a seasonally adjusted annual basis in June, the second-highest reading during 1999. Economists were expecting a rise of 892,000, according to

Reuters

.

The strength in this week's economic reports has, in the market's mind, increased the odds that the Fed will raise the fed funds target rate from the current 5% at its next meeting, Aug. 24. The market's been on watch for inflationary news since Fed head

Alan Greenspan

delivered harsh words at his semiannual

Humphrey-Hawkins

testimony last Thursday. Yesterday's 1.1% rise in the ECI, a broad measure of labor costs, marked its greatest increase in eight years, adding to the negativity.

The two-year note, which reacts to expectations for monetary policy, was performing worse than the 30-year bond today, having risen 5 basis points in yield today to 5.65%. The difference in yield between the 30-year bond and two-year note has narrowed to 36 basis points from 50 basis points July 21, the day before Greenspan's speech.

"I do think the curve is going to continue to flatten, reflecting a bias toward additional doses of Fed tightening," said Blough.

The dollar was at its lowest level against the yen since Feb. 12. Investors find U.S. assets more attractive when the dollar is strong, so erosion in the dollar's strength produces some flight to other countries' assets. The dollar fell to 114.79 yen today from 115.43 yesterday. The euro was weaker against the dollar today, down to $1.0692 from $1.0722 yesterday.