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Treasury Yield Curve Continues to Steepen

The 30-year bond's yield, which last week moved higher than the 10-year note's, is now also higher than the five-year note's.

The disinversion of the Treasury yield curve continued, with the 30-year Treasury bond's yield ending the day higher than the five-year note's for the first time since January. Last week, the bond's yield crept higher than the 10-year note's for the first time since January.

The 30-year bond's price (and the benchmark 10-year note's), continued to fall, while shorter-maturity issues gained ground, based mainly on the assumption that the

Fed will not hike interest rates again, and may even lower them in the next several months if economic growth slows too much.

The difference between short- and long-maturity Treasury yields is mainly a function of the Fed's monetary policy stance. As long as the Fed is inclined to raise short-term interest rates, investors are willing to accept relatively low long-term rates, since short-term interest rate hikes lead to slower economic growth. When the Fed stops being inclined to raise short-term rates, the inducement to buy long-term Treasuries at low yield levels goes away. "If the Fed is not raising rates there's no incentive to remain in that trade,"

Bear Stearns

Treasury market strategist Avram Altaras said.

There was no major economic news today, but bond market analysts said the selloff in the stock market helped drive bond investors toward the conclusion that growth will slow enough to keep the Fed from hiking the

fed funds rate again, and possibly enough to make the Fed ease.

For no other apparent reason, the odds that the Fed will lower the fed funds rate by the end of next year's first quarter spiked today, to nearly 85% from less than 50%, as indicated by the prices of

fed funds futures contracts.

The 10-year Treasury fell 8/32 to 99 3/32, lifting its yield 3 basis points to 5.87%. Meanwhile, the 30-year bond sank 26/32 to 104 2/32, boosting its yield 6 basis points to 5.96%.

But shorter-maturity Treasuries rallied, dropping their yields 1 to 2 basis points.

At the

Chicago Board of Trade

, the December

Treasury futures contract fell 14/32 to 97 28/32.

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Long-term Treasury yields began rising relative to short-term ones several weeks ago when bond investors started drawing the conclusion that economic growth was slowing,

Donaldson Lufkin & Jenrette

Treasury market strategist David Ging said.

It has accelerated, Ging noted, as oil prices have moved into 10-year-high territory, threatening to curb the economy further. "Oil prices are not so much acting as an inflation catalyst as a tax on the economy, further depressing demand," he said.

In other words, if people believed that rising energy prices were going to translate into higher prices more broadly, they might expect the Fed to continue to hike short-term interest rates. Instead, they see high energy prices primarily as a threat to economic growth.

Consider the suffering stock market at the same time, "and you start thinking about a hard rather than a soft landing," Ging said.

At the same time, Bear Stearns' Altaras noted, the so-called disinversion of the Treasury yield curve is also a function of shifting expectations about the future supply of long-maturity Treasuries.

Long-term Treasury yields first dropped below short-term ones as their prices soared in January, when the federal government announced plans to reduce the supply of long-term Treasuries through

buybacks. Now, some of those expectations are being priced out of the market, as bond investors contemplate the possibility that Election Day could spell the end of the buyback policy. "The whole furor about the buybacks diminished a bit," Altaras said.

Economic Indicators

The

Housing Market Index

(

definition |

chart |

source

) held steady at 61 in September.