US Treasuries rally as oil spike takes center stage
Mon Aug 29, 2005 09:15 AM ET
NEW YORK, Aug 29 (Reuters) - U.S. Treasury debt prices rallied on Monday, as a jump in oil prices above $70 a barrel fueled concerns that high energy costs could obstruct economic growth in the world's largest economy.
The latest spike in oil prices was driven by Hurricane Katrina, which led to the shutdown of about 40 percent of the Gulf of Mexico's U.S. oil and gas production, aggravating already tight supplies.
"This morning, it was just a mark up on oil. But it's quiet. There's no economic data," said a trader at a primary Treasuries dealer on Wall Street. Activity overnight was subdued, with markets in London closed for a public holiday.
The bond market's gains were so closely tracking crude, so that as crude gave back some of its spike, trading at $69.25 (CLV5: Quote, Profile, Research) , so too did Treasury debt.
The benchmark 10-year note (US10YT=RR: Quote, Profile, Research) was 8/32 higher to yield 4.16 percent, down from 4.19 percent late on Friday. Earlier Monday, the benchmark note was up a hefty 13/32, knocking yields to their lowest level since mid-July at around 4.138 percent.
Two-year debt (US2YT=RR: Quote, Profile, Research) rose 2/32 and was yielding 4.03 percent, down from 4.07 on Friday.
The closely watched spread between two- and 10-year debt, which has narrowed dramatically in the last two weeks, widened on Monday by a basis point to 13.
Five-year debt (US5YT=RR: Quote, Profile, Research) rose 5/32 to yield 4.06 percent, compared with 4.09 percent on Friday. The 30-year bond (US30YT=RR: Quote, Profile, Research) added 15/32 for a yield of 4.35 percent, versus 4.38 percent on Friday.
Adding to the bond market's gains were growing views the Federal Reserve would raise short-term rates at each of its three remaining policy meetings this year, which would bring the federal funds rate to 4.25 percent.
Also, comments by Fed Chairman Alan Greenspan on Saturday that U.S. home prices could fall as the housing surge inevitably slows also helped to buoy Treasuries on views that a turnaround in house prices could dampen consumer confidence.
GAUGING THE OIL IMPACT
As Hurricane Katrina was making landfall in Louisiana, it was clear the rising bond market was more concerned about high oil prices' impact on economic growth rather than on their effect on inflation.
The bond rally could continue if upcoming data indeed show that oil is hurting consumer spending and slowing growth, giving the Fed less room to push rates higher.
Manufacturing, labor market and consumer confidence data this week will reveal whether oil prices at these levels have hit economic growth.
But conversely, should the data show higher oil prices are creating inflationary pressures, bond prices could fall, as inflation erodes the value of fixed-income investments.
First up on key U.S. economic data is is August consumer confidence data on Tuesday.
This is followed by Thursday's manufacturing report from the Institute for Supply Management while the highest on analysts' watch list will as usual be Friday's report on the U.S. employment situation in August.
FLATTENING CURVE
Addressing the possibility of the two-year, 10-year yield spread flattening out and even inverting, Padhraic Garvey, head of investment grade strategy at ING Financial, said both two-year and 10-year Treasury yields could head for 4.00 percent.
"I think the 10-year (bond yield) wants to get to 4 percent and ... that's very well the point from which we could see this (yield curve) inversion taking place," said Garvey.
Normally yields on long-term bonds are higher than those on short-term maturities, reflecting investor desire for a higher return for tying up their money for longer periods.
Investors usually interpret a situation where long-dated bond yields are lower than short-dated bond yields to mean that an economic recession, or at least a slowdown, could be looming.
But traders said this time around an inverted yield curve did not necessarily imply a recession, pointing to the high amounts of liquidity supporting the back end of the curve. 
