Treasuries Follow Oil on Slippery Slope

Mon Nov 1, 2004
By Pedro Nicolaci da Costa

NEW YORK (Reuters) - Treasury debt prices slid on Monday as a sharp retreat in oil prices below $50 a barrel suggested energy might take less of a toll on U.S. economic growth than previously thought.

In the wake of falling crude prices (CLc1: Quote, Profile, Research) , the benchmark 10-year note (US10YT=RR: Quote, Profile, Research) was down 13/32 in price for a yield of 4.08 percent, compared with 4.03 percent at Friday's close.

"Oil is definitely one factor -- the drop gives the Fed more flexibility in terms of its tightening cycle," said David Ging, fixed-income strategist at Credit Suisse First Boston.

Federal Reserve officials have argued tirelessly that the spike in energy prices was a temporary phenomenon and therefore not a considerable threat to consumption.

While some policy-makers had started to acknowledge the detrimental effects of costly oil in recent weeks, a continued decline in crude would certainly give the central bank more leeway to continue raising interest rates.

Traders said the market had an air of nervousness about it on the eve of a hotly contested U.S. presidential election. Many believe a drawn-out post-election legal battle like the one that followed the 2000 vote would benefit bonds, as sheer uncertainty draws investors into safe-haven debt.

But by contrast, expectations of such a debacle have been so widespread that a swift conclusion to the vote might actually damage Treasuries.

For now, bonds seemed bent on moving lower, with two-year notes (US2YT=RR: Quote, Profile, Research) losing 3/32, taking yields to 2.62 percent from 2.56 percent. The five-year note (US5YT=RR: Quote, Profile, Research) eased 7/32, sending its yield to 3.34 percent from 3.28 percent.

The 30-year bond (US30YT=RR: Quote, Profile, Research) shed 23/32, levering its yield up to 4.85 percent from 4.79 percent.

Treasuries had tried to march higher after the Institute for Supply Management's activity index fell to 56.8 in October from 58.5 the previous month. Analysts had looked for a rise to 59.0, but some expected a much higher result given the huge rise in Chicago index last week.

Production pulled back and backlogs eased, suggesting manufacturing had peaked for the time being. The employment index also dropped, to 54.8, a disappointment to those hoping for a revival in the October payrolls figures due on Friday.

Interest rate futures (0#FF:: Quote, Profile, Research) barely budged on the numbers as the market still believed the Fed will hike rates next week, though analysts felt the ISM data helped the case for a pause at the December meeting.

There is no coupon supply this week, but traders will be setting up for next week's quarterly refunding. The Treasury is expected to offer between $50 billion and $52 billion in new paper, with the details to be announced this Wednesday.

Other data released on Monday showed consumers were still spending more than they earned, while inflation stayed subdued. Still, the numbers were for September and considered dated by the market. Personal income rose 0.2 percent, while spending climbed 0.6 percent as buyers snapped up discounted autos.

Since income growth is running short of spending, the savings rate slowed again, this time hitting a mere 0.2 percent. Analysts assume this disparity cannot go on forever and at some point consumers will have to spend less and save more, perhaps retarding overall economic growth.

The Fed's preferred measure of inflation, the core personal consumption expenditures price index, rose a subdued 0.1 percent, taking the annual rate to 1.5 percent, well within the Fed's presumed comfort zone of 1 to 2 percent.





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