Bond Traders Fret About a Yield Reversal

Bond traders are worrying about a reversal in yields in coming weeks, if more investors begin to sense that the Federal Reserve isn’t committed to significant additional interest rate cuts.

Treasury bond yields, which had plunged in November and December in anticipation of Fed rate cuts, have bounced in a narrow range since early January, when the Fed made the first half-point cut in its benchmark short-term rate. A second half-point cut came Jan. 31.

On Tuesday Treasury yields rose after Fed Chairman Alan Greenspan, testifying before Congress, seemed to hint that the central bank was surprised by the economy’s resilience in January, after a sharp slowdown late in 2000.

Two-thirds of major Wall Street bond dealers still expect another half-point rate cut at the Fed’s March 20 policy meeting, according to a Reuters poll. That would reduce the Fed’s benchmark short-term rate to 5%.

But some analysts said Treasury bond yields could begin to rebound from recent levels if investors lose faith in an ongoing Fed campaign to cut rates.

Carey Leahey, senior U.S. economist at Deutsche Banc Securities, said that after seeing stronger-than-expected January retail sales and hearing Greenspan’s “reasonably positive” statements on the economy, Treasuries are “on guard.”

The yield on the two-year Treasury note rose to 4.72% Tuesday from 4.67% Monday. The yield was at 5.10% at year’s end, then fell as low as 4.56% by Feb. 1 before moving up again.

The yield on the 10-year T-note rose to 5.07% Tuesday from 5.05% Monday. It is just slightly below where it ended the year, though it had spiked to 5.30% at the end of January.

Shorter-term bond yields, in particular, are “still priced for aggressive [Fed] easing, and any comments or data we get that hint that the Fed can afford to be less aggressive leaves the [market] vulnerable,” said Bill Hornbarger, fixed-income strategist at brokerage A.G. Edwards & Sons.

If data on U.S. consumer confidence to be released Friday show a pickup in sentiment, it could be “a real killer” for bonds this week, Leahey said.

“If the slide in consumer confidence is over, that supports the case for a V-shaped [economic] recovery,” he said.

Conventional mortgage rates generally follow the yield on the 10-year T-note, experts note. The drop in mortgage rates in recent months has helped buffer the housing market.

John Jacobs, bond analyst at Ideaglobal.com, said he expected Treasury yields to rise as the market “starts to adjust to a less aggressive timetable of Fed easing.”

“Greenspan sounded a more balanced note and economic data point to slower growth, rather than to a recession,” Jacobs said.

Though the bond market may be vulnerable near-term, analysts doubted a dramatic rebound in yields is on the horizon.

Anthony Karydakis, senior financial economist at Banc One Capital Markets, said some bond traders are hedging their short-term bets, which could cause indigestion in the market for a while.

Even if the economy has stopped eroding, Karydakis said, whether it has started to improve is a separate question.

“Whether we’re out of the woods yet remains to be seen,” he said.

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Holding Pattern

The yield on the two-year Treasury note has traded in a narrow range since early January after diving in November and December.

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2-year T-note yield, weekly closes and latest

Tuesday: 4.72%

Source: Bloomberg News