The bond market continues to trade poorly as the Fed has found a solution
to its low rate conundrum, inflation fears. 10 year notes are trading at
4.48% this morning and the tone remains poor. Initial Jobless Claims came
in higher than expected, but with Fed speak continuing to state that the
Katrina effects are temporary, investors are discounting the data. Even Fed
Governor Olson (the lone dissenter to the 25bp tightening at the September
meeting), expressed more concern about inflation than economic weakness.
The level of bearishness is very high. It wasn't very long ago that high
gas prices were an tax on the economy that would slow growth, but the
consistent talk from the Fed has changed that to high gas prices are
inflationary. Some analysts have raised their Fed funds target to 5% by the
end of 2006. The yield curve is steepening, indicating inflationary
pressures. Will the tightening and higher long rates unwind the housing
bubble? Certainly homebuilding stocks indicate some slowing as many are
near 6 month lows.
What to do here? 5 years and in offers some value as yields there are the
highest since mid 2002. Long rates are more problematic. If the FOMC keeps
their "measured" language in their statements, long rates will stay under
some pressure.(I don't think you see 5% 10 year notes anytime soon. 4.75%
at most). If "measured" is dropped, and the market starts pricing in 50bp
moves long rates will move lower. The Fed has created the perception that
they are behind the curve on inflation, its up to them to create the
perception that they are not.
Jim Rice
Taxable Fixed Income Trading
D.A. Davidson & Co.