Longer-Term Treasury Bond Yields Rise Sharply

Is the Treasury bond market’s rally over?

The Federal Reserve’s surprise rate cut Wednesday was followed by a sharp jump in longer-term T-bond yields--suggesting that those yields may already have priced in a significant number of cuts by the Fed in its key short-term rate.

The price of the 10-year Treasury note experienced its biggest one-day decline since July 1996, a sell-off that boosted the yield on the note to 5.16% from 4.92% Tuesday.

The yield on the five-year T-note rose to 4.98% from 4.76% Tuesday.

To be sure, the Fed’s cut in its target for the federal funds rate, the overnight loan rate among banks, to 6% from 6.5% did help pull down other short-term market rates.

The three-month T-bill yield, for example, sank to 5.66% from 5.85% Tuesday. The one-year T-bill yield fell to 5.08% from 5.17%.

But many investors in longer-term securities apparently decided to bail out, after riding the stunning drop in yields on those issues in recent months.

Indeed, even with Wednesday’s surge, the yield on the 10-year T-note remains well below its level of 6.03% at the end of July.

Treasury yields rose in part Wednesday because some investors sold bonds to buy stocks, traders noted.

Treasuries had a stellar 2000, with bonds and notes maturing in more than one year having their best year since 1995 in terms of “total return”--price gain plus interest earned.

Government debt last year outperformed the three major U.S. stock indexes, with the 10-year T-note returning 16% overall.

But now, “Bonds are in a tough spot,” said Joseph Keating, who manages $11.5 billion of assets for Lyon Street Asset Management in Grand Rapids, Mich. If the Fed boosts the economy and helps stocks, bonds may again become an afterthought to many investors, he said.

At this point, the Treasury market may need a full-blown recession to justify lower yields, some experts say.

“From here on in, Treasuries will be an underperforming instrument,” said David Kotok, chief investment officer at Cumberland Advisors in Vineland, N.J.

Others aren’t so sure. Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management, said he will keep assets in Treasury bonds and in government-sponsored debt.

“The markets think the Fed is going to bail them out one more time, but I’m not sure the medicine from the Fed this time will be as potent as in previous cut [cycles], such as in 1998 and 1991-1992,” Gross said.

It’s too soon to say if an improvement in financial market conditions will come soon enough to reduce the risk of investing in anything but the safest securities, he said.

Meanwhile, yields on corporate bonds, including “junk” issues, fell Wednesday, sharply in some cases.

The rate cut “sets some good groundwork” for a better market for junk bonds, said Jerry Paul, who helps manage about $1.5 billion worth of bonds for Invesco Funds in Denver.

The threat of a recession, along with an increase in defaults and earnings disappointments, contributed to make junk bonds the worst-performing fixed-income assets in the U.S. last year.