Updated from 11:33 a.m. ESTBonds snapped a four-session losing streak Tuesday, after the 10-year yield hit a 21-month high at 4.80% and traders warily made their way back to a battered market. "Yields have now backed up into our buy zone," says David Ader, RBS Greenwich Capital's U.S. government bond strategist, referring to 10-year yields near 4.75% and two-year yields heading for 4.80%. "We do remain bullish on the year but are cautious to dive back in just yet," says Ader. Ader believes that a variety of buyers, including foreign investors and participants looking to cover short positions, will find these levels attractive. But not much of a bid has fully developed, he says, because it is difficult to judge where the floor is ahead of the market-moving payrolls report. The 10-year yield ended the day up 4/32 of a point to yield 4.73%, while the 30-year bond gained 12/32 to yield 4.71%, recovering from a nearly half-point slide in the morning. The two-year edged higher 1/32 to yield 4.75%, while the five-year gained 2/32 to yield 4.76% and 4.75%. Longer-dated maturities, such as the 10-year note and the 30-year bond, typically yield more than shorter-dated notes, because it's riskier to loan money for longer periods of time. But falling prices on the short end of the curve have lately pushed rates above those on the long end, causing an "inverted" yield curve, something that has been a reasonably reliable leading indicator of economic slowdowns in the past. Bond prices and yields move in opposite directions. But the inversion between yields on 10- and two-year notes narrowed to just 2 basis points, after the curve went to a positive slope (i.e., "uninverting") by three basis points in intraday action. This is the flattest the curve has been in weeks, as the market waits evidence that the economy is strong enough to justify yields at their highest levels since June 2004. Michael Cheah, a portfolio manager with AIG Sun America Asset Management, points out that the Fed has said its future moves are all data-dependent, but that economic indicators are not sending clear messages.
In news that may have kept a floor under Treasuries, fourth-quarter productivity fell by 0.5%, a reading that was upwardly revised by 0.1% from the original 0.6% decline. Wall Street expectations were for fourth-quarter productivity to show only a 0.1% decline. But it's the February jobs report, to be released Friday, that the market really cares about. Wall Street is looking for the creation of another 210,000 new jobs, which would be consistent with a tightening labor market and more Fed hikes. But the Federal Reserve's own Survey of Consumer Finances shoots some holes into the theory that a stronger labor force could result in more spending and inflationary pressures. From 1998 to 2001, before-tax median family income -- expressed in 2004 dollars -- increased from $38,800 to $42,500, a nearly 10% gain, the survey found. Over the next three years, it rose only to $43,200, a 1.6% gain. The report also found that the mean income level declined to $70,700 in 2004 from $72,400 in 2001, down 3.6%. The mean level rose from $61,700 in 1998 to $72,400 in 2001. Cheah and Ader also say that the market is not paying enough attention to bearish economic indicators, including the softening housing market. Recent negative sentiment has made it difficult to find a place to get back into the market, they say, and until the payrolls report is out the way, the market could be frozen at these levels. January consumer credit rose by $3.9 billion, below expectations for a $5 billion gain that would be more typical of a post-holiday season spike. The year-on-year rise softened to a 13-year low of 2.2%, but whether that's because new bankruptcy laws force larger minimum payments or because Americans are spending less is up for debate. Hawkish comments overnight from St. Louis Federal Reserve President William Poole added to the recent bearish backdrop, with Poole saying that the Fed will raise interest rates so long as economic data look strong. In an interview with Reuters, he also said that it is safer to err on the side of being more restrictive than to risk inflation. "The weakness in the bond market ... shows the market has fully priced in a 5% fed funds, plus something more," says Cheah, who is still bullish on bonds in the long term. He believes that the Fed has more on its mind that just killing inflation. "The Fed has a dual mandate to fight inflation and also keep the economy healthy and be responsible for job creation. "For bonds to price in 5% fed funds and beyond is too excessive," Cheah says. "Think about what will happen to the mortgage market and the stock market. The Fed will take this into account and be wary of firming too much."
Ader says that recent price action has been in part a result of the market repositioning to price in efforts by the central bank to stem inflation. But he wonders if we are also seeing the "long-awaited deleveraging of the global financial system." "In conversations with customers and others, it has become obvious ... there is a suspicious absence of any major fundamental trigger," he says. "At the beginning of March, we knew the
Bank of Japan would soon end its quantitative easing policy, the European Central Bank was tightening, and the Fed had at least two more quarter-point hikes to go. What has changed? Nothing but the price action." Selling has hit fixed-income markets worldwide on signs that the ECB and the Bank of Japan will begin to raise their historically low interest rates and tighten their money supplies. Tony Crescenzi, chief bond market strategist at Miller Tabak and a RealMoney.com contributor, says that if interest rates worldwide rise, that could make Treasuries less attractive to foreign investors. The reason is that as rates go higher around the world, the Treasury market may no longer be the only safe haven where foreign investors can get a real return. The Bank of Japan has a policy meeting Wednesday and Thursday, when central bankers could raise interest rates now that the Japanese economy has shown some life. The Bank of Canada on Tuesday raised its overnight rate 25 basis points to 3.75%, as expected; and the European Central Bank raised rates by a quarter of a point last Thursday to 2.50%, its second hike in the last three months. No matter where the Fed takes rates, Crescenzi wrote in a recent RealMoney column , Treasury yields will follow. "The line that I have repeated more often than any other since last year is that Treasuries rarely trade below the fed funds rate," he writes. "It is a simple rule of thumb, one that helps explain the most recent behavior of the bond market, which today has weakened to its most fragile point in years." The Treasury said it will sell a lowered $18 billion in four-week bills Wednesday to raise approximately $4 billion in new cash. It also said it will auction $8 billion in 10-year notes on Thursday, in a reopening of last month's sale. This is less than the $9 billion in 10-years that Wall Street had been expecting. To make room for all this new debt, the Treasury will redeem retirement fund assets and suspend new investments in civil service funds as to avoid hitting its credit limit. ( Read this to see what happens when the U.S. maxes out its credit.) The Treasury is waiting for Congress to raise the legislated debt ceiling, and may have to use more dramatic "accounting devices" until more credit is approved. Legislative approval seems inevitable since Congress itself passed the fiscal year 2006 spending that necessitates the government's level of borrowing. The auction could weigh on the market as traders sell older notes to make room for the new issue. Corporate bond issuance could also be a drag on Treasuries, with GE Capital, Siemens AG ( SI) and Daimler Chrysler ( DCX) all ready to sell debt.