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Yield Curve Inverts as Bonds Enjoy Equities' Decline

The bond market crossed the

streams today.

Another day of outperformance by the benchmark Treasury bond caused inversion in the yield spread between two-year notes and 30-year bonds after the futures closed at 3 p.m. EST, a sign strategists often take to indicate that the economy will slow in coming months. It comes one

day after the 30-year bond rallied to yield less than the five-year note, and it's the first time the two-year/30-year spread has inverted since June 1990.

At 3:30 p.m., the twos/30s spread was just barely inverted, with the two-year note yielding 6.51% and the 30-year bond yielding 6.508%. That's down from an 11-basis-point difference at 8:30 a.m. this morning. Treasuries, which spent most of the day underwater, recovered in the afternoon due to a dive in the equity market. The 30-year Treasury was lately up 27/32 to 95 1/32, with the yield down 6.2 basis points to 6.508%. The 10-year note was down 5/32 to yield 6.68% and the five-year note was down 8/32 to yield 6.65%.

Historically, an inverted yield curve signals the market's anticipation of tighter, more restrictive Fed policy, low inflation and a slowing economy. But with the

Treasury Department

planning on buying back $30 billion in long-dated securities later this year, demand for falling supply has been the dominant

theme expressed as the 30-year bond rallied to yield less than the 10-year note and five-year note.

"I would look at fives and 10s as the market," said Michael Krauss, chief technical strategist at

Chase Securities

. "They are not acting well at all. The Fed still has a loaded gun and the bond market does not have a lot of upside."

But with the inversion impending, there was more talk about the market's expectations for the economy and the

Federal Reserve

. (Inversion means the longer-dated security yields less than the shorter-dated security.)

"Everyone is discounting the fact that it might be a reflection of a rational response to a potentially aggressive Fed action," said Mitch Stapley, chief fixed income officer at

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in Grand Rapids, Mich. "With a twos/30s inversion, fundamentals are more driving the long end than simply these technical things."

With the

fed funds futures

traded on the

Chicago Board of Trade

pricing in 75 basis points of Fed rate hikes by July, it's hard to argue that the market doesn't expect forceful action from the Fed. Though the Fed is taking a gradualist approach by raising the fed funds target 25 basis points at a time, officials' public comments seem to indicate determination to slow the economy.

"The Fed probably will take an inverted curve as meaning they need not overdo it here," said Peter Kretzmer, senior economist at

Bank of America

. "They'll have confidence that their medicine is starting to work."

But the gradualist approach, according to Krauss, while ultimately achieving the Fed's goal of draining a bit of economic strength, isn't going to give the Treasury market relief soon. He thinks long bond yields will rise to 6.80% to 6.90% before improving in the summer.

"It's not bullish for the right reasons historically," said Krauss. "This is the first time we've ever had buybacks. Right now, this is not bullish because the Fed is being very gradual."

The market is awaiting tomorrow's one-two combo of the fourth quarter

Employment Cost Index

, an important measure of wage inflation, and the fourth-quarter



CME to List Agency Options


Chicago Mercantile Exchange


said it plans to list new contracts tied to the growing market for notes issued by the country's largest home lending agencies. The new five- and ten-year agency note futures and options contracts will be sized at $100,000 and listed with quarterly expirations. It plans to launch the contracts during the first quarter. The announcement comes after the CBOT made a similar

announcement this week.

Economic Indicators

The market initially weakened after a 4.1% increase in

durable goods orders

for December, which far outpaced the market's expectation for a 0.8% increase, according to


. The strength in durable goods is inflated due to an incredible 16.2% increase in transportation orders in December after a 3.8% decrease in November. Orders for civilian aircraft were the chief reason for the 16.2% increase. Those orders increased 53.3% in December, and that's extremely unlikely to be repeated two months in a row.

Excluding transportation, orders rose 0.7%, after a revised 2.5% increase in November. Excluding defense, orders were up 3.5%. On a year-over-year basis, durable orders rose 8.9%, according to the

Commerce Department



initial jobless claims

rose 1,000 to 266,000 from a revised 265,000, which becomes the lowest reading for claims since December 1973. Economists were expecting 278,000 in jobless claims, according to


. The four-week moving average fell to 288,000 from a revised 290,250 the previous week.


Conference Board's

help-wanted index

rose to 86 in December from 85 in November.

The ECI is expected to rise 0.9% in the fourth quarter, according to


consensus estimates. "I think the ECI will be fairly benign," said Kretzmer. "If that occurs, the trend we see will continue, in terms of the curve flattening and inverting."

Currencies and Commodities

The dollar was stronger against the euro and weaker against the yen. It fell to 105.09 yen, from 105.71 yesterday. The euro fell below parity with the dollar and continued to weaken, lately at $0.9881, from $1.0009 yesterday.

Crude oil for March delivery at the

New York Mercantile Exchange

fell to $27.32 a barrel, from $27.84 yesterday.


Bridge Commodity Research Bureau Index

rose to 211.69 from 211.08 yesterday.

Gold for February delivery at the


rose to 287.1 from 286.5 yesterday.