It should be little surprise that U.S. Treasury long-dated bond prices moved lower with stock prices in the wake of the Sept. 11 tragedy. Fiscal surpluses were already in doubt with the economy teetering on a recession (and already in one in manufacturing), and the Bush administration and Congress cut taxes but faced difficulty cutting spending.

The Sept. 11 attack put tax receipts at risk as firms cope with lost sales or shut their doors permanently, while consumers remain in shock, avoiding normal trips to the stores and malls. On the spending side, the government quickly approved $40 billion to rebuild New York and cope with some of the new demands on national security. The notion that a second fiscal stimulus of $100 billion in tax cuts may be needed has gained traction in the Bush administration and in Congress, despite warnings from

Fed

Chairman Alan Greenspan to proceed cautiously.

Talk of the 30-year bond disappearing has been silenced -- perhaps we will be looking at a 50-year bond soon. Supply fears have rattled the Treasury market and sent many into the short end of the yield curve, generating record-low yields on two-year notes and a surging eurodollar market as more Fed easing is discounted.

On top of the supply concerns, there are huge liabilities to be met by insurance firms that hold longer-dated fixed-income securities andespecially U.S. government debt. Insurance companies have upped the cost of the tragedy to $30 billion, while some are saying the cost will be $40 billion or more. Insurance companies will be regular sellers of Treasuries, keeping supply concerns amplified.

Sure, those who put on steepening trades (long the short end and short the long end) have prospered. But this may only be the start of this trade.Greenspan has all but guaranteed the Fed will cut rates by another 50 basis points next week, and who's to say that will be it? Another 100 basis points is plausible.

Then there are the inevitable inflation expectations that the long end has hardly priced in ... massive monetary and fiscal stimulus and an eventual U.S. recovery will send longer-dated yields up even more.

I can only imagine the distortions the Sept. 11 tragedy will have on the real economy in the short run. But few have considered what distortions the tragedy will surely generate for the fixed-income area of the financial markets in the months ahead.

David Gilmore is an economist and partner of Essex, Conn.-based Foreign Exchange Analytics, a currency markets advisory service for institutional investors. Neither the author nor Foreign Exchange Analytics trades in the currency markets. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

fxa@fxa.com.