Wednesday Look Ahead: Rate Spike Breaks Holiday Week Doldrums

The bond market will be the one to watch Wednesday, after interest rates spiked following a sloppy Treasury auction Tuesday.

NYSE trader
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NYSE trader

There is no economic data scheduled for release, but the government's auction of $29 billion in 7-year notes now has the attention of traders in all markets, as they watch to see whether the rate move had more to do with razor thin volumes or a trend toward higher interest rates. The government's auction of $35 billion 5-year notes at 1 p.m. Tuesdaysaw the lowest demand since June, prompting further selling.

"Everything I look at tells me this is not a market you want to sell because the risk is a vicious rally...and the time of the year, like last December, we had a dramatic sell off and responded with a 40- to 50-basis point rally in January," said David Ader, chief Treasury strategist at CRT Capital. Rates on the 10-year were at 3.33 percent early in the day Tuesday, and were at 3.48 by day's end.

"It's entirely about the date and has nothing to do with the information. Today we got two piece pieces of weak data, Case-Shiller home prices and consumer sentiment, and those otherwise could have been supportive. It's more about whose around to buy and it's who wants to carry it over year end," said Ader, who had predicted the messy auction in an earlier interview last week.

Ader noted Tuesday that the last time the Treasury auctioned 5-year notes, bond market volume was much higher. Tuesday's volume was 48 percent of that day's total. The outsized move also follows a period where rates had backed off of mid-December's high yields. On Dec. 15, the 10-year hit a high 3.56 percent intraday, and the 30-year was at 4.62 percent, two basis points shy of unchanged for the year.

"When it gets to this arena, you get to the calendar effect...the bearish momentum was reversed last week. It's losing steam, even as prices have a fallen a bit, the momentum is going the other way, suggesting the bear market is tired. A lot of the things I look at say we're supposed to do better," said Ader.

Harris Private Bank Chief Investment Officer Jack Ablin said the rate move is not a negative for stocks, but it bears watching.

"Yesterday, the 2-year auction went pretty well. I'm inclined to kind of withhold judgment until we get a real full market," Ablin said. "'s hard the last week of the year, when you have light volume, you can have outsized moves even in the most liquid markets, and so I'm not sure I'd read anything into it yet. When we reconvene next week, if rates are here, then there's something really notable to mention, like perhaps demand for Treasurys is beginning to wane."

Treasury Building
Treasury Building

Ablin said he expects to see rates rise next year, and the 10-year could end 2011 with a yield closer to 4.5 percent, a move he does not believe would stop stocks from advancing. Traders have debated the reason for rising rates, even in the face of the Fed's purchase of Treasury securities. Many believe it is a response to improving economic data, and not necessarily a negative for the stock market. Others believe it is concerns about the unchecked U.S. federal budget deficit or the threat of creeping inflation.

Stocks Tuesday were mixed, with the Dow ending up 21 at 11,575 and the S&P 500 up less than a point at 1258. While strategists expect a positive 2011, traders are increasingly talking about how excess bullishness could portend a pull back in stocks.

"If we were to sustain some kind of drop off in January, I would use it as a buying opportunity. I'm looking past January to fill up my shopping basket of stocks," Ablin said.

He expects the stock market to gain only about 7 percent in the coming year, about half of what some strategists expect. "I think there is enough of a valuation cushion built into stocks that they can withstand a pretty substantial rate rise and not be upset," he said.

Other market moves of interest Tuesday included another up day for copper, which hit its second record high this week. Copper closed up over 1 percent at $4.3280 per pound, after setting a record high of $4.3350. The Reuters-Jefferies CRB index of 19 commodities settled at tits highest level since October 2008, as oil, soy beans and wheat also hit more than two-year highs.

The dollar gained 0.3 percent against the euro , which was at 1.3119.

The best performing stock sectors Tuesday benefited from the commodities rally, with energy shares leading, up 0.4 percent, followed by materials, up 0.3 percent.

General Motors shares rode back into favor on Wall Street, as more than a half dozen firms christened its six-week old stock market debutwith buy or overweight ratings.

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