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Bond Brief: Minute Reaction

Notes from the FOMC's Jan. 31 meeting do little to change the tone.

Updated from 2:56 p.m. EST

Treasuries caved to inflation worries Tuesday after

Federal Open Market Committee

meeting minutes reinforced rate-hike expectations while revealing little else about policymakers' thinking.

In corporate debt, struggling automaker

General Motors

(GM) - Get Free Report

saw its bonds further slashed, to B2 from B1, by Moody's.

Minutes from the FOMC's Jan. 31 meeting revealed that the assembled central bankers believe inflation expectations to be a touch elevated due to energy costs and a stronger labor market, but that the threat is "subdued."

"In the view of some members, the possibility of additional policy moves was reinforced by readings on core inflation and inflation expectations that were somewhat higher than was desirable over the long run," the FOMC said in minutes released this afternoon.

"You are listening to the same song again, but sometimes when you hear something over and over, it finally sinks in," says Steve Bohlin, a portfolio manager at Thornburg Investment Management.

"The Street has been resistant to further fed moves for about a year now ... the Fed minutes helped solidify that 4.75% is probably not the stopping point for fed funds," says Bohlin. "The ability to be sanguine about inflation at this point is getting harder and harder."

The benchmark 10-year note ended the day down 7/32 to yield 4.56%, while the 30-year bond was down 13/32 to yield 4.53%. Bond prices and yields move in opposite directions.

In shorter-maturity debt, the five-year was up 1/32 of a point to yield 4.59% and the two-year was unchanged on the session to yield 4.70%. Treasury markets were closed Monday for Presidents' Day.

The notes from Alan Greenspan's last policy meeting as chairman also repeated assurances that core inflation should remain tame and that further rate hikes will be dependent on data.

"Although heightened inflation pressures could also arise from possible increases in resource utilization, the outlook for economic growth and the stability of inflation expectations suggested that core inflation should remain contained over time," the statement said, adding that headline consumer inflation has been "held down by falling consumer energy prices."

Tomorrow's consumer price index report for January will be scrutinized for signs of inflation, with expectations for a 0.5% rise and a 0.2% gain at the core.

The Federal Reserve raised the overnight lending rate to 4.50% at the January meeting, the fourteenth straight quarter-point hike since June 2004.

The statement was in line with Fed Chairman Ben Bernanke's testimony before Congress last week that suggested there is more tightening ahead.

The fed funds futures contract has priced in near-certain odds that the bank lending rate will hit 5.0% by June.

Despite the focus on the Fed minutes, the Treasury market won't begin to heat up until Wednesday, with the release of the CPI for January, says David Ader, chief U.S. government bond strategist at RBS Greenwich Capital.

"The most compelling upcoming events are the $36 billion of Treasury supply and the incoming inflation data," Ader says.

The Treasury will sell $22 billion in two-year notes on Wednesday and $14 billion in five-years on Thursday.

Traders will shuffle holdings to make room for the new debt, which weighed on the short end. And Bohlin added that skittishness over whether foreign investors would put in a strong showing at the auctions also held down prices.

Economic reports released Tuesday included the Conference Board's index of leading indicators, which reinforced the foregone conclusion that inflationary pressures will push the Fed to continue raising rates. The index jumped a sharp 1.1% in January vs. market expectations for a 0.6% climb.

Not only was the result nearly double expectations, it marked the largest jump in seven months and a record high at 140.1.

The index is a basket of economic indicators that includes unemployment benefit claims and building permits, and is intended to forecast economic trends up to six months ahead. Six of the 10 components strengthened in January.