U.S. Treasury Prices Rise Strongly

September 22, 2004
By Ros Krasny

CHICAGO (Reuters) - U.S. Treasury prices rose strongly on Wednesday in response to rising oil prices, weak equities and lower inflation prospects.

Yields on the benchmark 10-year note (US10YT-RR), which move inversely to prices, moved below 4.0 percent for the first time in five months.

Sliding U.S. stock prices boosted Treasuries on a day when some strategists had expected the opposite.

The blue chip Dow Jones industrial average fell 1.3 percent to its lowest in more than three weeks, and technology stocks suffered deeper losses.

A surge in NYMEX crude oil futures (CLc1) above $48.50 per barrel to within sight of record highs also fueled Treasuries buying. The latest oil price spike suggested gas prices at the pump could climb again after a few weeks' respite.

High energy prices act like a tax on consumers, cutting into disposable income, and could crimp hiring and capital investment if business confidence is bruised.

"Investors are wondering: 'Is the rise in oil prices going to curtail consumer spending?' Is it going to hold businessmen back from hiring?"' said Josh Stiles, senior bond strategist at IDEAglobal.

Sluggish sales at major chain stores have been blamed partly on high gasoline prices, and demand for big-ticket items such as autos has also suffered.

General Motors Corp. (GM), the largest U.S. automaker, will hold a three-day sale with interest-free loans of up to six years to clear bulging inventories. "This suggests the soft patch is not over yet," said David Sloan, senior economist at 4CAST Ltd.

On Wednesday, American Airlines raised fares for most trips in North America to help offset the high cost of jet fuel. American, the world's largest carrier, said high jet fuel costs would add more than $1 billion to its expenses over the coming year.

A report on August durable goods orders on Friday will give a reading on how the economy is faring after a wobbly summer. Wall Street forecasts orders to be flat compared with July.

Initial strength in bonds followed the Federal Reserve's comment after its policy meeting on Tuesday that inflation expectations "have eased in recent months."

The comment was taken by dealers as a license to buy, even with bond prices already high.

Gains were exaggerated by short-covering from firms caught flat-footed by recent strength.

Falling inflation prospects and the recent string of Fed rate hikes have helped narrow the spread between 10-year and two-year note yields to 153 basis points, a three-year low.

Speculators also bought on ideas that mortgage-related "convexity buying" could be triggered if the 10-year yield falls toward 3.90 percent. Dealers have seen little of the anticipated mortgage sector buying so far.

Figures from the Mortgage Bankers Association early on Wednesday showed new refinancing applications up for a third straight week, climbing 4.1 percent.

Brokers expect rapid mortgage prepayments if yields fall further. Adjustable-rate mortgages taken out earlier this year could be shifted to fixed-rate loans. The average 30-year mortgage rate is at the lowest since March.

The 10-year Treasury note rose 15/32 for a yield of 3.98 percent, down from 4.04 percent late Tuesday. Yields are at a major retracement point from the June 2003 low to the June 2004 high.

The 30-year bond (US30YT-RR) jumped 1-2/32, yielding 4.77 percent, down from 4.84 percent. Five-year notes (US5YT-RR) were up 5/32 to yield 3.25 percent, against 3.28 percent. Two-year notes (US2YT-RR) were steady at a yield of 2.47 percent.

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