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September 5, 2000

Treasuries Retrench As Oil Fears Weigh
By Daniel Sternoff, Reuters

Bond Market Retraces False Steps ... Weiss comments

NEW YORK - U.S. Treasuries slumped in Tuesday morning trading as spiking oil prices fanned inflation fears and dealers cast a second glance at optimistic forecasts a slowing economy will ease price pressures.

Treasury prices sagged as traders returned from the long U.S. Labor Day holiday weekend to find crude oil prices soaring near 10-year highs, souring the market's mood after weak economic data on Friday fueled hopes the Federal Reserve will not raise interest rates for the foreseeable future.

Long-term Treasury yields, which move inversely with prices, bounced off year lows hit on Friday, when the bond market cheered reports showing the manufacturing sector shrank in August while tight U.S. jobs market eased.

"I think we went too far, too fast," said Scott Graham, co-head of governments trading at Prudential Securities.

"Oil is going to be a concern, especially for the back end of the marketplace. Certainly any kind of inflation is not going to be helpful," he said.

Traders also said the Treasury market would likely face an uphill battle in coming weeks as a deluge of corporate supply is expected to hit the market in September.

International benchmark Brent crude oil futures for October jumped to a decade peak of $32.88 in overnight trading -- well above the $30 mark which triggers U.S. alarm bells -- before easing a tad.

U.S. light crude futures also briefly lurched above $34 for the first time since March, when prices were at their highest since early 1991.

In morning trading, 10-year notes (US10YT-RR) slipped 6/32 to 100-9/32, yielding 5.71%. The 30-year Treasury bond (US30YT-RR) tripped 12/32 lower to 107-31/32, sending its yield to 5.69%.

Five-year notes (US5YT-RR) fell 3/32 to 103-10/32, yielding 5.93%, while two-year notes (US2YT-RR) dropped 2/32 to 100-1/32 with a yield of 6.10%.

Friday's market-friendly reports provided more concrete proof the economy is slowing to a pace less likely to spur inflation pressures, underscoring the view that six Fed rate hikes from June 1999 to May 2000 are enough for now.

But dealers said the market was perhaps too zealously optimistic in its belief the economy is cooling.

John Roberts, head of governments trading at Barclays Capital, said August car sales data released late on Friday were strong and predicted a spike in retail sales in the back-to-school season.

"I think you will see a pretty big rebound in consumer demand now that summer is over. I just don't think the consumer is as dead as people think," Roberts said.

Bond prices got a big boost from economic news on Friday, but it was only temporary. Bond investors tend to be a lot more skeptical than most stock investors, and now that they've had a weekend to think about it, the news wasn't worth celebrating.

Today, prices are dropping as the bond market reflects on its over-enthusiastic reaction to the economic reports of the past week amid skyrocketing oil prices. Clearly, the bond traders recognize that rising oil prices can throw a wrench into any plans to tame inflation by slowing down the economy. As we have said before, oil prices can single-handedly fuel inflation. In addition, the bond market knows that consumer spending has not begun to ease -- new home sales and auto sales are strong, and back-to-school shopping is expected to go up sharply. To the bond market, strong consumer spending and high oil prices translate into sure signs that inflation is coming down the pipeline.

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