Fed Rate Cut Triggers Bond Market Tremors
Wednesday November 6, 4:01 pm ET
By Ross Finley and Wayne Cole
NEW YORK (Reuters) - Tremors shot through the U.S. Treasury market on Wednesday, leaving most
prices slightly higher, after the Federal Reserve delivered a shock half-point interest rate cut, but
strongly signaled they were not planning to cut again.
The cut was double the quarter
percentage point the market had
expected and took the Fed funds
rate to a fresh four-decade low of
1.25 percent.
"Wow. Very surprised, very
surprised," quipped Sharon Stark,
chief fixed income market
strategist at Legg Mason in
Baltimore, right after the
announcement.
But traders were baffled by the
Fed's decision to shift its
assessment of economic risks to
neutral, away from weakness,
suggesting the bank saw no need
to ease further.
After some hesitation, stock
investors, who had been hoping
for such an aggressive cut
following an equity-friendly
Republican sweep of Congress in
the mid-term elections, took the
major indexes modestly higher, up about 1 percent.
"The Fed is signaling it thinks this is enough to carry the economy through the next several meetings,"
said Brad Stone, head of U.S. market strategy at Barclays Capital Group, explaining the limited gains
in Treasuries.
"By changing the bias it's expressing confidence in the recovery, perhaps in the hope of getting
investors out of safe havens like bonds and into risk-taking with equities and corporate debt," Stone
said.
Many in the market expected the Fed to cut by a quarter point on Wednesday followed by another
quarter point when it meets for the last time this year, in December. So the aggressiveness of the cut
took many off guard.
The move will also put pressure on the European Central Bank and the Bank of England, which both
meet Thursday to set interest rates. Pressure on the ECB in particular to cut rates has been building
with many of Europe's economies, led by Germany, underforming sluggish U.S. growth.
By 3:45 p.m. EST, two-year Treasury notes (US2YT=RR) were off 2/32 in price, taking yields to 1.85
percent from 1.82 late Tuesday. But some trades right after the cut when Treasuries first surged put
yields as low as 1.64 percent, close to a new record low.
The benchmark 10-year note (US10YT=RR) rose 7/32 for a yield of 4.05 percent from 4.07 percent.
Earlier, a well received auction of 10-year notes had resulted in a record low yield for these maturities.
They traded at 4.03 percent.
At the Chicago Mercantile Exchange, December Eurodollar futures (EDZ2) settled 9.5 basis points
higher at 98.635, off a high of 98.700, pricing in today's easing but no more.
REPUBLICAN SWEEP BAD FOR BONDS
With the Republicans now controlling the U.S. Senate and the House, traders were fretting that
President Bush will be better able to push through tax cuts and spending plans. That could see ever
wider budget deficits and the issue of more bonds to pay for them, so forcing rates higher.
"It will have significant and protracted implications for Treasuries, and all of them bad," said Ifty Islam,
head of U.S. fixed income strategy at Deutsche Bank Securities.
"The supply outlook will worsen not just next year but for years to come. We're surprised the market
hasn't reacted more negatively," he said.
The $18 billion sale of new 10-year notes Wednesday produced a record low auction yield of 4.095
percent and attracted bids for 1.9 times the amount on offer, well up on the miserable 1.29 seen last
August.
FED: "SOFT SPOT"
Policymakers signaled they would likely stand pat after the half-point cut, saying risks to the economy
were balanced between weakness and inflation and that the reduction should help the economy
through its "soft spot."
But many traders were skeptical the risks had all of a sudden fallen into line in one fell swoop.
"Risks are balanced, they hope; no, they pray," said Sadakichi Robbins, head of global fixed income
at Bank Julius Baer in New York.
For the second time in a row, the Fed cited uncertainties stemming from a possible war with Iraq,
saying these were holding the economy back.
"Incoming economic data have tended to confirm that greater uncertainty, in part attributable to
heightened geopolitical risks, is currently inhibiting spending, production and employment," the Fed
said in its post-meeting statement.
"The committee believes that today's additional monetary easing should prove helpful as the
economy works its way through this current soft spot," it added.
A growing volume of recent data has suggested the slow recovery from last year's recession is faltering
badly -- new orders for costly manufactured goods are falling, October new-car sales were down from a
year earlier in a worrying sign for consumer spending, while October also saw a second straight
monthly decline in payrolls outside the farm sector.
The vote to cut interest rates was unanimous.
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