Treasury note and bond prices rose, dropping yields to new lows for the year, as a selloff in the stock market increased the appeal of debt securities as an alternative investment.
Early in the session, Treasury prices fell after a key inflation report was hotter-than-expected. But as people realized that the increase in prices was not broad-based, the market recovered somewhat. A weaker-than-expected report on the industrial sector of the economy spurred it to further gains. But the stock selloff provided the biggest reason of all to buy Treasuries, Credit Suisse First Boston market strategist Mike Cloherty said. "If stocks are going down, people are likely to try and move into more stable, more secure investments," he said. The benchmark 10-year Treasury note rose 9/32 to 104 9/32, dropping its yield 3.3 basis points to 5.180%, the lowest since April 1999. Shorter-maturity yields also declined to new lows for the year. The 30-year Treasury bond rose 7/32 to 112, lowering its yield 1.5 basis points to 5.427%, the lowest since February 1999. At the Chicago Board of Trade, the March Treasury futures contract rose 8/32 to 104 25/32. The early blow to the market came from the Consumer Price Index ( definition | chart | source ), which measures prices paid by consumers for goods and services. The core CPI, which measures the prices of goods and services excluding food and energy, whose prices are volatile, rose 0.3% in November. Economists polled by Reuters had forecast a 0.2% rise, on average. The annual growth rate of the core CPI rose to 2.6% from 2.5%, matching its highest level of the year. That sounded a mild alarm about inflation, prompting investors to sell Treasuries, whose value depends on inflation remaining under control. They reconsidered upon learning that a large increase in tobacco prices was largely responsible for the increase in the core CPI. "That's not anything that tells you about price trends in the broader economy," Cloherty said. Consumer prices of all goods and services, including food and energy, rose 0.2% in November, in line with economist expectations. The annual rate of increase held steady at 3.4%. The industrial production ( definition | chart | source ) for November was unambiguously positive for bond prices. Industrial production unexpectedly fell 0.2% in November, providing additional evidence of economic weakness. Economists had forecast it would be unchanged on average. As production fell, the capacity utilization rate, which measures anti-inflationary slack in the industrial sector of the economy, found more of it. The rate fell to 81.6%, the lowest since November 1999. The industrial production report merely returned bond prices to around unchanged on the day. Treasuries didn't start rallying till the stock market's distress deepened. In addition to creating demand for Treasuries as an alternative investment, the selloff brought more people into the camp that believes the Fed will lower interest rates in the months ahead. The price of fed funds futures contracts rose, indicating that investors are increasingly willing to believe that rates will come down. The February fed funds futures contract, for example, discounted 124% odds that the Fed will lower the rate to 6.25% from 6.5% currently by the end of January. Treasury market professionals say the market is discounting at least three 25-basis-point cuts in the fed funds rate by midyear, more than the Fed is likely to deliver. But they say the Treasury market rally can continue, driving yields ever lower, as long as stock prices continue to fall. There is also a paradoxical element to the rally in Treasuries, J.P. Morgan's head government bond trader Tom Connor said. The longer the Fed goes without lowering interest rates to stimulate the economy, the more it will ultimately have to lower them. So while most people expect the Federal Open Market Committee to leave rates unchanged at its final meeting of the year on Tuesday, that's no barrier to higher Treasury prices. "Yields can continue to go lower till the market gets some idea of the trajectory of the Fed," he said.
In other economic news, real earnings ( definition | chart | source ) fell 0.1%, as a 0.2% increase in the CPI offset the 0.1% gain in average weekly earnings reported by the November employment report.
Currency and Commodities
The dollar rose against the yen and fell against the euro. It lately was worth 112.56 yen, up from 112.16. The euro was worth $0.8948, up from $0.8905. For more on currencies, see TSC's Currencies column. Crude oil for January delivery at the New York Mercantile Exchange rose to $28.87 a barrel from $27.99. The Bridge Commodity Research Bureau Index rose to 227.41 from 226.02. Gold for February delivery at the Comex rose to $272.90 from $271.50.