Treasurys Fall Ahead of Fed Decision

The Associated Press
Monday, December 10, 2007; 5:51 PM

NEW YORK -- Treasury prices dropped Monday as bond market investors tried to gauge Federal Reserve monetary policy a day ahead of a critical Fed decision on rates.

Many bond market investors believe the Fed is likely to cut rates Tuesday, but that the reduction likely will only be 0.25 percentage point and that it will mark the final easing in this cycle.

In prior weeks, investors were more convinced that a 0.50 percentage point rate cut is possible this week and that future Fed meetings would bring additional easings.

"The Treasury market is trading lower this morning as more and more investors feel that the Fed is close to the end of its short-term 'ease cycle' and that the U.S. economy is not as weak as many thought," said Kevin Giddis, managing director of fixed income at Morgan Keegan.

"There is also the thought that the rate reductions by the Fed have a future price: inflation."

The bond market always keeps inflation in its sights because higher price pressures dent into the value of fixed income instruments. Still, the market would welcome a rate cut Tuesday because it would stimulate strained capital markets.

The benchmark 10-year Treasury note fell 16/32 to 100 26/32 with a yield of 4.15 percent, up from 4.12 percent late Friday. Prices and yields move in opposite directions.

The 30-year long bond dropped 1 point to 106 8/32 with a yield of 4.61 percent, up from 4.58 percent on Friday.

The 2-year note fell 3/32 to 99 30/32 with a yield of 3.15 percent, up from 3.10 percent rom late Friday.

The yield on the 3-month note dropped to 3.07 percent from 3.12 percent late Friday as the discount rate fell to 3.00 from 3.05 percent Friday.

Further selling in after hours trade, sent yields up further. The 10-year yield at 5:30 p.m. Eastern time reached 4.16 percent, as the 30-year yield rose to 4.62 percent and the 2-year yield increased to 3.18 percent.

But the 3-month yield fell to 3.04 percent and the discount rate dropped to 2.97 percent.

As the year draws to a close, the Fed is under unusually strong pressure to make sure financial markets are liquid, and this has increased certainty that the central bank is likely to cut rates Tuesday.

The need to keep money in circulation always increases right before the year-end as consumers ramp up their spending for the holidays and institutions grapple to square their books and improve their balance sheets. These usual seasonal pressures this year are compounded by the fact that credit markets are over-stressed.

"This year, in addition to seasonal needs for money in the financial system, the Federal Reserve must contend with extraordinary demands for liquidity, the likes of which have not been season at year's end since 2000 when concerns about the impact of the advent of the millennium were rampant," said Tony Crescenzi, fixed-income analyst at Miller Tabak.

New real estate sector data Monday backed the view that the economy may not be weak enough for the Fed to sustain a series of rate reductions beyond Tuesday. However, it is also thought that in the current cycle, the Fed's decisions are based as much on concerns about the health of the credit markets as on indications about the strength of the broader economy.

The National Association of Realtors reported that its pending home sales index rose 0.6 to 87.2 in October from 86.7 in September. The September level was revised higher from an original reading of 85.7 and followed two large declines in July and August.

"The back to back monthly gains and slowing in the year on year slide gives some hope that the worst might be over for the housing market," said Action Economics. "

"The data are of interest, but ahead of tomorrow's Fed decision and more important economic reports later in the week, there won't be much market reaction this morning."

© 2007 The Associated Press