Yield Curve Steepens as Fed Outlook Shifts - TheStreet

Treasuries ended mixed today, as short-maturity issues rallied while longer-term issues fell. On the whole, the day's trade reflected shifting sentiment about the Fed, market analysts said. As more and more people embrace the idea that the Fed may be done hiking interest rates, they are banking on long-term interest rates rising relative to short-term ones, analysts say.

Influencing prices at various points were this morning's weaker-than-expected May

retail sales

report, midday comments by

New York Fed President

William McDonough

, and another big rise in oil prices. A

speech by Fed Chairman

Alan Greenspan did not directly comment on monetary policy.

The benchmark 10-year Treasury note ended down 8/32 at 102 25/32, lifting its yield 3.4 basis points to 6.079%. But while the two-year note rallied 2/32 to 100 7/32, dropping its yield 2 basis points to 6.498%, the 30-year bond fell 31/32 to 104 7/32, hiking its yield 7.1 basis points to 5.945%.

Over the course of the day, the 30-year's yield went from 64 basis points lower than the two-year's to just 55 basis points below.

At the

Chicago Board of Trade

, the September

Treasury futures contract fell 25/32 to 96 23/32.

Most of the Treasury market, with the exception of the bond, got a lift from the early news that retail sales fell 0.3% in May, and that the April decline was revised to 0.6% from 0.2%. The bond market welcomes evidence that economic growth is slowing because slower growth takes pressure off the Fed to hike interest rates.

Even after stripping out the 1.3% decline in auto sales in May, retail sales were weaker than expected. They were unchanged, vs. an average forecast they would rise 0.3%, and an unchanged reading for April was revised to a 0.4% decline. "The latest news on retail activity reinforces the impression that consumer spending is decelerating, and as such, it provided more evidence to support the view that the Fed will be on hold at the June 28 meeting,"

Daiwa Securities

chief economist Michael Moran said in a research note, referring to the next meeting of the

Federal Open Market Committee.

But then, starting at about 11:30 a.m. EDT, simultaneous selling of long-dated Treasuries while buying short-dated ones went into high gear. The trade was driven, trading desk sources said, by the spreading belief that signs of a slowing economy will become even more widespread, keeping the Fed from hiking rates again at any point this year.

Here's how it works: When the Fed was clearly in the process of hiking the

fed funds rate, many traders bet that long-term Treasury yields would decline relative to short-term ones. Short-term Treasury yields tend to stay in the general vicinity of the fed funds rate, while the Fed's aggressive stance lowers the inflation expectations that determine long-term yields. To bet on a decline in long-term yields relative to short-term ones, traders buy long-dated issues while selling short-dated ones.

Now that people have started to believe the Fed may be done hiking rates, they anticipate long-term yields rising relative to short-term ones. Accordingly, they sell long-dated issues while buying short-dated ones. That was what was going on today, market-watchers said. "It really has been people buying the front end and selling the back,"

Merrill Lynch

Treasury market strategist Jerry Lucas said.

"There's simply a perception that with the weak economic data of the last two to three weeks, the Fed's on hold and maybe through with its tightening campaign," explained Richard Bodkin, a government bond trader at

Banc One Capital Markets

in Chicago.

The entire Treasury market moved down in price around midday in response to McDonough's assertion, in a

speech in Albany, that inflation could still accelerate. "While it might be tempting in this environment to sit back and declare victory," McDonough said, "nothing would be more foolish. There is no question that the U.S. economy, especially in relation to the world economy, is beginning to exhibit signs of imbalance and strain."

McDonough highlighted rising oil prices, which also put pressure on long Treasuries today, Banc One's Bodkin said. Rising oil prices threaten to lead to higher prices more generally, and oil futures neared the nine-year highs they last hit back in March. "The long end was pressured a bit by developments in the commodity markets, most notably oil," Bodkin said.

Economic Indicators

In other economic news, the two weekly retail sales reports also detected weakness. The

BTM Weekly U.S. Retail Chain Store Sales Index fell 0.1%, its second consecutive drop. Previously, the index had not fallen for two weeks in a row since November. Meanwhile, the

Redbook Retail Average found June sales running 0.4% behind May after two weeks, compared to 0.3% last week.

Currency and Commodities

The dollar rose against the yen and fell against the euro. It lately was worth 106.92 yen, up from 106.84. The euro was worth $0.9595, up from $0.9532. For more on currencies, please take a look at


Currencies column.

Crude oil for July delivery at the

New York Mercantile Exchange

rose to $32.56 a barrel from $31.74.


Bridge Commodity Research Bureau Index

rose to 224.88 from 224.58.

Gold for August delivery at the


fell to $288.10 an ounce from $289.10.