US Treasuries drop as Fed chief rosy on economy

Tue Jul 20, 2004
By Pedro Nicolaci da Costa

NEW YORK, July 20 (Reuters) - U.S. Treasuries fell on Tuesday as traders interpreted Fed Chairman Alan Greenspan's optimism on the economy as a signal that the central bank could raise interest rates more quickly than anticipated.

Speaking before the Senate Banking Committee, the Federal Reserve chief said the U.S. economy had entered a self-sustainable expansion that was generating some price increases, but not enough to threaten the recovery.

Just after Greenspan began his remarks, the benchmark 10-year note (US10YT=RR: Quote, Profile, Research) had lost 23/32 in price, lifting its yield to 4.45 percent from 4.36 percent late on Monday, and still a long way from the 4.88 percent high seen just last month.

"The bond market had been thinking that the weak economic numbers that we've seen would cause the Fed to think twice about raising rates," said Gary Thayer, chief economist at A.G. Edwards & Sons in St. Louis, Missouri.

"But it looks like Mr. Greenspan is saying the slowdown in the economy will be short-lived and that suggests that the Fed will probably continue to raise rates."

However, U.S. economic data continued to point to a slowing U.S. economy, with a housing report on Tuesday showing construction starts for June dove 8.5 percent to a much-lower-than expected 1.802 million. Housing permits for declined 8.2 percent.

But Greenspan's optimistic forecasts offset the housing decline, sending the two-year note (US2YT=RR: Quote, Profile, Research) down 7/32 in price, lifting yields up to 2.64 percent from 2.52 percent on Monday. The five-year note (US5YT=RR: Quote, Profile, Research) eased 16/32, leaving its yield at 3.67 percent from 3.56 percent.

"The bond market reaction will evolve as the Fed Chairman keeps speaking," said Parul Jain, deputy chief economist at Nomura Securities. "It's a talk that kind of hedges both ways. The bond market sentiment will be buffeted around as this talk proceeds."

"But on the whole there was also the presumption that the earlier rally was a little bit overdone," Jain added. "A lot of good news had been factored in right after June core CPI reading released on Friday -- so the market was primed for a little bit of a sell-off."

At the long end of the curve, 30-year bonds (US30YT=RR: Quote, Profile, Research) shed 1-3/32, taking yields to 5.13 percent from 5.11 percent.

Short-term interest rate futures slipped to reflect a 70 percent chance that the Fed will raise rates by another quarter point at its Aug. 10 meeting, to 1.5 percent, from 66 percent before Greenspan's testimony. Futures still suggest a year-end fed funds rate close to 2 percent.

Other data out on Tuesday suggested the consumer spending still had not picked up after tailing off sharply in June. The ICSC/UBS measure of chain store sales rose a slight 0.2 percent last week and annual growth slowed to 3.3 percent, its lowest level since August last year.

The most recent batch of data had shown that the U.S. economy was still expanding at a fairly strong clip, although some key indicators pointed to a softening in consumer spending and a slowdown in job creation.

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