Treasuries Take A Post-Fed Breather

But this day of selling shouldn't be a deterrent in the coming weeks for the bond market, analysts believe, because the trend for the last two weeks has been a positive one.
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After two days of euphoria following the

Fed's

rate hike, the bond market took a breather today, as traders took profits and selling ensued. But this day of selling shouldn't be a deterrent in the coming weeks for the bond market, analysts believe, because the trend for the last two weeks has been a positive one.

"Price movements not related directly to a news release really identify a trend," said John Blough, market strategist at

Fahnestock

. "It's indicative of a firm trend in place that can do better, especially if we get friendly numbers."

The market's optimism was rediscovered almost two weeks ago with the release of the unchanged July

Producer Price Index

, and continued through last Tuesday's benign

Consumer Price Index

report. The yield on the 30-year rallied to 5.85% yesterday, a positive reaction to the Fed's neutral-sounding statement. Lately the 30-year Treasury bond was down 14/32 to trade at 103 12/32. The yield rose 4 basis points to 5.89%.

As an isolated incident, the post-rate-hike rally is not indicative of a trend, Blough said, but in this case, it helps continue one that was already established. But there are potential stumbling blocks for the market ahead, least of all Sept. 3's release of the August

employment report

. Currently the forecast is for 206,000 in new nonfarm payrolls, but economists were burned with a similar forecast in July, when payrolls came in at 310,000, 100,000 more than expectations. Back in mid-July, when the

Labor Department

conducts its survey, jobless claims were near historical lows, as they have been in the last few weeks.

Initial jobless claims

fell to 283,000 last week from the previous week's revised figure of 288,000, the Labor Department said. The four-week moving average rose to 283,750 from the previous week's 281,500 figure.

The market ignored this figure, as well as today's revision to second-quarter

GDP

. Second-quarter GDP was revised downward to 1.8% from 2.3%, but that doesn't mean the economy is slowing. The figure was revised because of downward revisions to business inventories and a widening in the trade deficit. Again, the strength in consumer demand is to blame -- businesses allowed inventories to run down as consumers snatched up lots of goods, and the trade deficit widened not because of falling exports, but because consumer spending continues to support the growth of imports.

"We've effectively seen two tightenings since the second quarter so there was a little bit of a 'this is old news' perspective on the numbers, given the changes in Fed policy since then," said John Canavan, Treasury market analyst at

Stone & McCarthy Research

.

The market is already thinking about the third-quarter report (though that's still two months away). Due to the rise in business investment economists already believe third-quarter growth will fall somewhere around 4%, and that means the economy hasn't slowed at all. Which is why the market can't discount the possibility that the Fed could raise rates again before the end of the calendar year (though it seems to be doing just that). Blough believes the long bond probably won't rally below 5.75% with the funds rate currently sitting at 5.25%.

This afternoon, the Fed released

minutes from its June 29/30 committee meeting, where it decided by a 9-1 vote to raise the fed funds target to 5% from 4.75%.

Dallas Fed President Robert McTeer

voted against a rate hike, believing there were few signs of inflation.

The minutes show the central bank members were more or less very worried about inflation, but could only see it in recent reports on wage compensation and in anecdotal surveys. If anything, these minutes provide more evidence that the Fed is going to continue to be cautious in the coming months.

Oddly enough, the minutes also show that committee members were divided as to whether to retain a tightening bias at the June 29/30 meeting. Some felt, according to the minutes, that not retaining the bias would "foster the misleading conclusion that the committee no longer believed a further adjustment to policy might be warranted at some point later this year." The Fed misleading? Not possible.