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Bonds Close Slightly Up as Stocks Dip

Reuters
Monday, 24 Sep 2007 | 4:08 PM ET

U.S. Treasury prices finished mostly higher Monday, shaking off an early decline and benefiting from a downturn in the stock market.

In general, stocks have risen while Treasurys have been driven lower in the wake of the Federal Reserve's decision last week to reduce official rates by a full half percentage point.

However, on Monday stock gains evaporated in mid-session, causing Treasury prices to strengthen, although the gains were tepid and did not alter the fixed-income markets' negative view of the recent rate decision.

Since the rate cut, the stock market has focused on the positive implication that less expensive money will stimulate growth, while the Treasury market has fretted over inflation. Cheapening the cost of money tends to tempt sellers to lift prices, setting off inflation, which the Treasury market detests.

"Fixed-income markets, after initially rejoicing, are now feeling the wrath of the bonds vigilantes," wrote economists at Action Economics.

The benchmark 10-year Treasury note rose 1/32 to 100 31/32 with a 4.62 percent yield, down from 4.63 percent at Friday's close. Prices and yields move in opposite directions.

The 30-year bond rose 5/32 to 101 28/32 with a 4.87 percent yield, down from 4.88 percent at Friday's close.

The 2-year note finished unchanged at 99 29/32 with a 4.05 percent yield, matching the level of its close on Friday.

The yield on 3-month Treasury bills ended at 3.69 percent, up from 3.65 percent as the discount rate gained 0.09 percentage point to 3.71 percent.

Fed Chairman Ben Bernanke in a speech about education and education avoided any mention of monetary policy, disappointing investors who had hoped for clues about the central bank's next rate move.

Kevin Giddis, managing director of fixed income at Morgan Keegan, said uncertainty about the outlook for rates and the economy has left some investors uncertain about what to buy.

"The bigger question to be answered: Should they own bonds at all at these levels? The likely answer depends on which maturity you think best matches your rate forecast." Giddis said.

Investors who believe the Fed will continue to ease credit and push the federal funds rate lower, probably will want to purchase short-term notes with a maturity of no longer than 5 years, in his view.

"If you feel that the Fed will take a break, look at the economic growth with a critical eye, and only cut rates again when it feels that the economy is about to go into a recession, then you would likely benefit from buying bonds on the longer end of the yield curve," Giddis said.

Investors tend to buy longer-dated bonds when the economy appears weak and there is a solid motive for loaning money long-term.

Ashraf Laidi, chief currency analyst at CMC Markets, said pricing in the federal funds futures market indicates that markets expect the Fed will cut rates by at least another half percentage point in coming months.

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