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Bonds Drop as Traders Brace For Rate Hike

Reuters
Thursday, 5 Jun 2008 | 1:49 PM ET

Treasury debt prices fell after a surprise drop in weekly jobless claims soothed recession fears and increased expectations the Federal Reserve will raise interest rates later this year.

The market slide deepened in the wake of remarks from European Central Bank President Jean-Claude Trichet hinting at a possible rate increase by the ECB in the second half of the year to contain rising inflationary pressure.

Losses were curbed by lingering worries about the financial sector, which has been rattled by fresh speculations about write-downs and downgrades by bond rating agencies, analysts and investors said.

The latest jobless data, a day prior to the government's closely watched monthly payroll report, spurred buying in stocks and pared safe-haven bids for bonds.

"They support our belief that the economy is much better than many give it credit for," said Kim Rupert, managing director of global fixed income analysis with Action Economics in San Francisco.

The government said first-time filings for unemployment benefits slipped to 357,000 last week, the lowest in six weeks, from an upwardly revised 375,000 in the previous week.

The latest claims figure was lower than the most optimistic of 40 estimates in a recent Reuters poll.

ECB in Protracted No-Change Period
We are in for a protracted period of no change in European interest rates, Kevin Sullivan from Clariden Leu told CNBC after the central bank held rates Thursday. Stuart Bennett from Calyon discusses.

Benchmark 10-year Treasury notes traded 11/32 lower in price for a yield of 4.02 percent versus 3.98 percent late Wednesday.

Two-year Treasury notes, most sensitive to the market's Fed outlook, traded 3/32 lower for a yield of 2.50 percent, versus 2.45 percent late Wednesday.

Major stock indexes were broadly higher with the S&P 500 up 15 points or 1.1 percent.

Trichet Echoes Bernanke

ECB's Trichet hawkish comments came a day after Fed Chairman Ben Bernanke's inflation remarks. Trichet went as far to suggest the ECB could raise rates as early as next month.

"I don't say it's certain, it's possible to move in July," Trichet said at ECB's monthly news conference after it left benchmark euro zone rates at 4 percent for 12 straight months.

In the meantime, Bernanke and other Fed officials have stepped up their inflation rhetoric, noting current US. rate levels will promote growth later this year. The Fed's stand hassupported the view that the Fed will keep rates unchanged through at least the summer.

"Recession talk is going away and the attention has turned inflation," said Kevin Mahn, chief investment officer at Hennion & Walsh in Parsippany, N.J.

Richmond Fed President Jeffrey Lacker told Reuters that risk of a sharp economic contraction has "definitely receded" but "overall inflation has come in uncomfortably high."

U.S. rate futures implied traders are fully pricing in the prospects of the Fed leaving the key federal funds target rate at 2 percent after its next policy meeting in three weeks.

They also show traders see more than a 50 percent chance of the Fed raising rates at its October policy meeting. This compared with a 44 percent chance shortly before the data.

Rate futures showed traders see the Fed hiking rates by a quarter percentage point by year-end.

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