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How the Bond Markets React 03.14.05
Reasonable Attention
It has become a pricing issue in the fixed income markets. This led to a dramatic sell-off last week pushing the 10-year Treasury note to a yield of 4.54%. This is a significant move in a week, with the yield settling at levels not seen since last July.
The attention lavished on the fixed income came with the realization that there are inflation pressures at work on economic growth. And if that is the case, the price, which moves in the opposite direction as the yield, was far too high to absorb this news.
The dollar hit the skids as well as currency investors had to parse the mumblings of another Asian nation, talk that was quickly muted by another lesser government official. This is the second time in as many weeks that one of America's biggest debt customers has had some public doubts about their investment strategy. Diversity is not a word to be taken lightly by those who trade dollars or by those who sell debt.
It took more that just inflation - which was hinted at in the Fed's Beige Book release - and the tumbling dollar. It was another seemingly unstoppable widening of the trade deficit. The President sees this as proof that the American economy is growing. Make that spending. Unfortunately, we are spending borrowed dollars. This is not, in the eyes of the fixed income market, a condition of growth.
The warning signs for the sell-off last week, apparently were right in front of everyone's nose. Even Greenspan, who warned us not once, but twice - first in the infamous conundrum speech, the one where he could scarcely believe that the long rates had not followed the short rates higher and secondly towards the end of last year when he suggested that only losses would occur should investors ignore the rising interest rate move he was orchestrating.
Greenspan really wanted a little help in doing his job. By not biting on the quarter point increases, 6 in all, the market had not permitted him the flexibility he required to make the moves he needed to, should, as we found out last week, inflation becomes a factor. Now, with that information is in the hands of investors, he can make the half-point moves he might need to make if in fact he so deems them necessary.
It is important to note as well, this new found understanding will play itself out even more dramatically in the mortgage backed securities. The long term effect in a shift in thinking will have ripple effects across the economy. Retailers depend on the wealth effect that inexpensive mortgages have provided, which will slow earnings among growth companies as inflation begins to whittle away at their current plans.
With the realization that long term rates may indeed begin to rise, something that has seemed almost impossible to every one but Greenspan, the unbridled optimism found among these investors has now been changed to reasonable attention.
Equity markets are also worried. If bonds become more attractive with lower prices, equity investors, who are now beginning to wrap themselves around the overvaluation of stocks, many may jump looking for those rock bottom deals with healthy yields.
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