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Inflationary pressures build Original Source Link: (May no longer be active)
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U.S. 10-Year Treasuries Fall as Fed Sparks Inflation Concern
May 4 (Bloomberg) -- The 10-year U.S. Treasury note fell in New York after the Federal Reserve signaled it can raise interest rates at a ``measured'' clip, suggesting to some investors that the policy may lead to faster inflation.
Fed policy makers dropped a pledge to be ``patient,'' saying the economy is expanding at a ``solid rate'' and ``hiring appears to have picked up.'' The central bank kept its target rate for overnight loans between banks unchanged at 1 percent, as predicted by all 97 economists polled by Bloomberg News.
``Inflationary pressures build as long as we have this emergency less-than-zero percent real interest rate,'' said Bill Gross, who runs the world's largest bond fund for Pacific Investment Management Co. in Newport Beach, California. The consumer price index rose 1.6 percent from a year ago in March. Inflation erodes the value of fixed-income payments.
After an initial rise, the 4 percent note due in February 2014 fell almost 1/2, or $5 per $1,000 face amount, to 95 17/32 at 5 p.m., according to Cantor Fitzgerald LP. Its yield rose 7 basis points, or 0.07 percentage point, to 4.57 percent. The yield on the 10-year note is up from 3.65 percent on March 17.
``At this juncture, with inflation low and resource use slack, the committee believes that policy accommodation can be removed at a pace that is likely to be measured,'' the Fed said in its statement.
Timing
Traders said there was nothing in the wording to move up the timing of a rate increase from next quarter. The 2 1/4 percent note due in April 2006, which is more sensitive to changes in monetary policy than longer-dated debt, was little changed at 99 7/8 to yield 2.32 percent.
``I wouldn't be surprised to see it in August,'' Gregory Hahn, chief investment officer at Carmel, Indiana-based 40/86 Advisors Inc., said of a rate increase. The firm manages about $26 billion in fixed-income assets. Prospects for higher rates make yields on current debt securities less attractive.
The Fed last year cited concerns about deflation, or a general drop in prices, for lowering its target rate to a four- decade low of 1 percent. Fed policy makers have since pointed to sluggish job growth and slow inflation as the main reasons for keeping rates unchanged.
Last week, the Commerce Department said a measure of inflation, the so-called price deflator, rose at a 2.5 percent annual rate, up from 1.5 percent in the fourth quarter and the fastest since mid-2001.
``The problem is that if you pull up a variety of inflation- related charts, we really have a wall of price increases in front of us and somehow the markets need to sort of deal with that,'' said John Poole, who manages $12 billion in bonds at Mellon Private Asset Management in Boston. ``The fear is the longer they wait to take these measured steps the more they are going to have do and the faster they are going to have to do it.''
Behind Curve
Also, companies are creating more jobs. Payrolls rose by 308,000 in March, the most in four years. The yield on the 10- year note saw its biggest one-day gain after the April 2 jobs report. The economy may have added 170,000 jobs in April, according to the median estimate of 73 economists surveyed by Bloomberg News. The report will be released on Friday.
``They basically recognized the fact that the job market is improving and that inflation data has been stronger but yet they still said that they don't see an increase in long-term inflation expectations,'' said Joseph Shatz, a senior government debt strategist at Merrill Lynch & Co. in New York. Merrill is a primary dealer.
The Fed should already have raised overnight lending rates to nip inflation before it gets out of hand, said investors including Warren Buffett, the world's second-richest man, and Gross.
``They never should have lowered it to this emergency/deflation-prevention level,'' Gross said in an e-mail to Bloomberg News before the statement. The Fed should lift its benchmark rate to 2.5 percent and ``should get there quick and not with baby steps.''
Interest-Rate Futures
The target rate may rise to 1.25 percent next quarter and to 1.50 percent by January, according to the median estimate in a monthly poll of 58 economists by Bloomberg News from April 27 to April 30. The yield on the 10-year note may climb to 4.7 percent in the third quarter and 4.95 percent in the final three months of the year, according to the median forecasts.
Interest-rate futures show traders expect the central bank to boost its target rate for overnight loans between banks next quarter, the same as yesterday.
September Eurodollar interest-rate futures yielded 1.735 percent, little changed from 1.74 percent yesterday. The yield is up from 1.33 percent on March 31. The yield is a gauge of a three- month lending rate that has averaged 0.22 percentage point more than the key federal funds rate in the past 10 years.
The percentage of investors betting on a decline in Treasury note prices rose to its highest ever -- 53 percent -- in a weekly poll of clients by J.P. Morgan Chase & Co. that began in 1992. The previous week 52 percent bet on declines.
`Two Bugaboos'
Investors are selling Treasuries at the same time the government is borrowing more money to finance a budget deficit that the Bush administration estimates will reach a record $521 billion this fiscal year ending in September. The deficit was $374 billion last year.
`The market is facing two bugaboos,'' said Mellon's Poole. ``Fiscal policy is still very loose and monetary policy is very accommodative. The Treasury market is going to continue to be under pressure.''
Ten-year note prices may move even lower as the prospect of a higher benchmark rate lessens the appeal of borrowing at variable short-term interest rates in order to invest in longer- term debt, said some investors,
``There has been a lot of incentive to borrow at 1 percent and put it to work at 4 percent,'' Kevin McKenna, who oversees $192 billion as head of fixed-income for the America's at the investment-management unit of Merrill Lynch in Plainsboro, New Jersey. ``Now people are less comfortable with what their financing cost is going to be.''
To contact the reporter on this story:
Monee Fields-White in New York at mwhite@bloomberg.net
To contact the editor of this story:
Robert Burgess at bburgess@bloomberg.net
Last Updated: May 4, 2004 17:22 EDT
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