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Inflation Fears Turn Treasuries Lower

Inflation Fears Turn Treasuries Lower
Friday March 18, 10:16 am ET

NEW YORK (Reuters) - U.S. Treasury prices swung lower on Friday as the week's wave of short-covering petered out, allowing underlying worries about inflation and the Fed to peep through.

The benchmark 10-year Treasury note (US10YT=RR) slipped 11/32 in price, so reversing all of Thursday's gains. Its yield rose to 4.51 percent from 4.47 percent, leaving it in the middle of the week's 4.44-4.58 percent range.

Traders said ripples from General Motors Corp.'s (NYSE:GM - News) profit warning on Wednesday were waning, taking the flight to quality bid with them. Instead, anxiety was building ahead of next week's Federal Reserve meeting and the release of key consumer price data.

"The spread widening from GM seems to be over for the moment and, without that impetus, nobody wants to buy bonds before such big events. Too much can go wrong," said one trader at a U.S. primary dealer.

"Oil is off its peak, stocks look like opening firmer and the dollar's bounced, which argues for selling (Treasuries) into strength from a day trading point of view," he added.

And sell they did, with the two-year note (US2YT=RR) falling 2/32 in price, lifting yields to 3.72 percent from 3.68 percent. The five-year note (US5YT=RR) lost 6/32, taking its yield to 4.17 percent from 4.14 percent.

At the long end, the 30-year bond (US30YT=RR) shed 23/32, lofting yields to 4.81 percent from 4.77 percent.

The early economic data showed import prices rose 0.8 percent in February, though most of the gain came from energy prices. Nonpetroleum prices were up only 0.2 percent on the month, while non-auto consumer goods prices rose 1.0 percent on the year suggesting only modest pass-through pressure as yet from the lower dollar.

The University of Michigan's consumer sentiment index for March dipped to 92.9 from 94.1 in February, surprising analysts who looked for a rise to 95.0. Still, such surveys have shown scant correlation to actual consumer behavior with spending still running strong in the last couple of months.

Federal Reserve Chairman Alan Greenspan speaks at midday though the topic of "Measuring the Impact of Community Economic Development Programs" suggests he might not say anything market-moving.

The same cannot be said for next week's events, which include major readings on U.S. inflation and a policy meeting of the Federal Reserve, which is almost certain to see interest rates rise for the seventh time this cycle.

An upside surprise in inflation would sorely test bonds and could easily see 10-year yields retest this week's peak around 4.58 percent on the way to last July's high at 4.64 percent.

As for the Fed, a quarter point hike has long been discounted but there is speculation the Board could drop its reference to tightening at a "measured" pace, an omission the market would take as raising the risk of half point increases in the future.

Fed watcher John Berry this week wrote the Fed would keep the word, though he gave no source for the assertion. Still, analysts assume it is just a matter of time before the Fed chooses to inject more uncertainty into the rate outlook given the economy is proving more resilient than many expected.

Lehman Brothers on Friday revised up its forecasts for economic growth this quarter and next to 4.5 percent and 4.0 percent respectively, from an initial 3.7 percent in each quarter.

"The stronger pace of activity seems fairly evenly balanced -- consumption, business investment, and housing are all proving stronger than expected," said Lehman's senior financial economist Drew Matus.

"In addition, we have penciled in another Fed rate hike, bringing the year-end funds rate to 3.75 percent. We expect the Fed to maintain its steady 25 basis point course through each of the next 5 FOMC meetings," he added.


LINK: http://biz.yahoo.com/rb/050318/markets_bonds_3.html