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A number of factors are behind today's weakness in the Treasury market, from speculation to forced selling to the developments on the global front.

One influence is the fact that the speculative long position held in five-year Treasury note futures is at a record high, according to the most recent data released by the Commodity Futures Trading Commission. In addition, the speculative long position held in 10-year T-note contracts is near a 16-month high.

Next, the open interest in both five- and 10-year T-notes has increased substantially of late, and for the five-year it is at a record high.

Additionally, forced selling is being seen from investors in mortgage-backed securities. These investors have been big buyers of Treasuries in recent months, owing to the continued decline in interest rates. As interest rates fall, the duration on mortgage-backed securities falls because of the level of prepayments, which rise because of increases in mortgage refinancing and home-buying. Now that interest rates have increased, the long hedges held in Treasuries are being liquidated. The duration on

Fannie Mae's

6.0% MBS has increased today to 1.9 years, from 1.6 years yesterday.

Also, the failure to rally on this morning's weak retail sales report illustrates the large extent to which bearish economic news is already built into prices. As for the retail sales report, numerous indicators pointed to weakness, including the blizzards along the East Coast, dismal chain-store sales, weak car sales and the loss of 92,000 retail jobs in February.

Another key factor is that the short end was approaching the fed funds rate. With the yield on the two-year T-note at just 1.33% on Monday, the issue was just 8 basis points over the 1.25% fed funds rate. The two-year dipped below the fed funds rate on only five occasions over the past 14 years, and each time, the

Federal Reserve

cut rates within months. Even if the Fed were to cut rates to 1.0%, the short end's proximity to the fed funds rate would still be too close for comfort for many investors.

Further consider that a critical measure of the degree of value in the Treasury market is the so-called real yield on the 10-year T-note. The real yield is the spread between the yield on the 10-year and the inflation rate. With the yield on the 10-year at about 3.60% in recent days and the inflation rate at about 2.6%, the real yield is at a skimpy 1%. Over the past 10 years, the real yield averaged 3.3%, and it hovered around 3% in the early 1960s, when inflation trends were similar to those of the current environment. The real yield averaged 2.8% over the past 40 years.


Reports that the CIA is in communication with Iraqi military leaders and is negotiating their surrender in the event of war are also having an influence on bonds. And by delaying a vote on a new U.N. resolution until next week, the White House has moved slightly toward a more multilateral approach. Unilateralism has been the bane of the equity market and a boon to Treasuries.

Add to that the fact that the U.K. proposal on benchmarks has gained traction, and Iraq may give information on the whereabouts or past destruction of its stockpiles of anthrax, nerve agents and other banned materials.

Finally, Fannie Mae's duration gap for February was reported today, and it suggested that the company's portfolio wasn't as short as feared. The duration gap was reported at minus five months, compared with minus four months in January. That change is small, considering the decline in market rates.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of

The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of

Bondtalk.com, a popular Web site covering the bond market and the economy. He appreciates your feedback and invites you to send it to

Tony Crescenzi.

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