The Federal Reserve began raising the federal funds rate on June 30, 2004, after it had sat at 1% for the better part of a year. At the time, the FOMC was worried about deflationary pressures. It's too bad they didn't look at the charts for crude oil and the CRB Index, as they were confirming a bottom.

Crude oil bottomed out just above $17 per barrel in November 2001, two months after 9/11. A year later, prices moved above $25. The upward speculative momentum for oil took off at the end of 2003 from around $32.50 a barrel. Where was the deflation?

The CRB Index formed a major double bottom on its monthly chart off of 183 in the first half of 1999, with a retest in October 2001. It seems to me that the FOMC's cut of the funds rate to 1% on June 25, 2003, signaled speculators to buy commodities, as charts show a clear upward momentum from 234 on the CRB at the end of June 2003.

In its worries over deflation, the FOMC flooded the world with liquidity, forcing the dollar much lower vs. the euro, and tempted traders and hedge funds to speculate not only on commodities, but also on real estate.

The FOMC helped the stock market bottom out between July and October 2002 with the funds rate at 1.75%. The Fed filled the punch bowl and the party continues, despite 11 rate hikes made by the Fed since June 2004 -- an attempt to reverse the mistake it made when it pushed the federal funds rate below 3% after 9/11.

The Bond Conundrum

The graph clearly shows that the bond conundrum (Fed Chairman Alan Greenspan's catch phrase for the fact that long-term yields were declining while the Fed was raising short-term rates) is ending. It began before the FOMC made the second of its 12 rate hikes, when the yield on the 30-year Treasury declined through and stayed richer than its 200-day simple moving average (5.112) on Aug. 6, 2004.

There were several points at which it appeared the conundrum might end, but each time the 200-day simple moving average held as support: Dec. 3, 2004 (5.059), March 23, 2005 (4.917), and Aug. 9, 2005 (4.621).

The pattern appears to be changing now. With the federal funds rate at 3.75%, and likely at 4.00% on Nov. 1, the yield on the 30-year is poised to trend above its 200-day SMA at 4.540. The close on Sept. 30 was also cheaper than its five-month modified moving average at 4.507, which shifted the monthly chart profile to negative, another sign that the bond conundrum is now over.

Another signal for higher yields would be if the 50-day SMA rises above the 200-day SMA, which, as the chart shows, could happen next week. The Fed's plan to remove monetary accommodation at a measured pace continues, despite the destruction of hurricanes Katrina and Rita. The Fed and most Wall Street economists say that the economic effects of the storms are temporary, but in my opinion, that's wishful thinking. I believe that the FOMC and Wall Street just don't understand Main Street, USA.

In my judgment, sagging income and higher energy prices will continue to depress consumer spending for months, if not quarters. The Conference Board and University of Michigan consumer sentiment readings plunged in September, and some economic statistics from before Katrina suggested that the economy was already slowing. For example, new-home sales fell 9.9% in August.

The ISM Index for September came in much stronger than expected Monday, but so did the prices-paid component. This fueled a rise in yields and thwarted a strong stock market open. On Friday, we will see the September Employment Report, which will show the effects of Katrina but not Rita. Nonfarm payrolls should be down 150,000 to 200,000, with the unemployment rate at 4.9%-5%. Wall Street and the Fed are likely to downplay the weakness as temporary.

I'd advise individual investors to keep those laddered fixed-income portfolios folded. Stay in money markets and Treasury bills.

U.S. Treasury Yields
Date 2-year 3-year 5-year 10-year 30-year 2s / 10s
June 30, 2005 3.658 3.668 3.722 3.943 4.218 28.5
Sept. 30, 2005 4.177 4.176 4.196 4.326 4.567 14.9
Change 51.9 50.8 47.4 38.3 34.9 -13.6
Value Area 4.380 M 4.367 M 4.532 Q 4.577 A 5.063 Q -8.1 M
4.664 Q 4.655 Q 4.626 Q 4.866 Q 5.104 A -12.5 Q
Supports 4.539 Q 4.672 Q
Pivots 4.220 Q 4.286 M 4.300 M 4.656 S 15.0 W
5-Week MMA 3.983 4.003 4.049 4.217 4.469 23.3
5-Month MMA 3.682 3.754 3.908 4.190 4.519 50.8
Resistances 3.978 W 3.985 W 4.004 W 4.175 M 4.453 W 64.4 Q
3.900 W 3.869 W 3.887 W 4.172 W 4.392 M
Risky Area 3.689 S 4.037 S
3.047 A 3.450 A 3.878 A 3.254 A 4.015 A 153.6 A
Source: Global Market Consultants

The Bond Conundrum
The yield on the 30-year bond is rising above its 200-day simple moving average, which may be a sign the bond conundrum is over
Source: Athena Graph on Telerate Plus

Richard Suttmeier is president of Global Market Consultants, Ltd., chief market strategist for Joseph Stevens & Co., a full service brokerage firm located in Lower Manhattan, and the author of Technology Report newsletter. At the time of publication, he had no positions in any of the securities mentioned in this column, but holdings can change at any time. Early in his career, Suttmeier became the first U.S. Treasury Bond Trader at Bache. He later began the government bond division at L. F. Rothschild. Suttmeier went on to form Global Market Consultants as an independent third-party research provider, producing reports covering the technicals of the U.S. capital markets. He also has been U.S. Treasury Strategist for Smith Barney and chief financial strategist for William R. Hough. Suttmeier holds a bachelor's degree from the Georgia Institute of Technology and a master's degree from Polytechnic University. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback -- click here to send him an email.