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September 18, 2000

U.S. Bonds Fall as Oil Near 10-Year High Stokes Inflation Worry
By Beth Thomas, Bloomberg

Bond Sell-Off Signals Inflation ... Weiss comments

LONDON - U.S. bonds fell on concern oil prices will extend gains that have seen the cost of a barrel of crude reach its highest level in a decade, stoking inflation.

"There are stories that the oil price could potentially reach $40 a barrel, and that's unsettling" to bond investors, said Michael Derks, a strategist at Commonwealth Bank of Australia.

The 10-year Treasury note fell 6/32 to 99 4/32, or $1.875 per $1,000 face value. The yield rose 3 basis points to 5.87%. Thirty-year Treasury bonds fell 14/32 to 104 13/32, driving the yield 3 basis points higher. December Treasury futures fell 11/32 to 97 21/32.

Oil reached $35.80 a barrel on the New York Mercantile Exchange recently, close to the decade's high of $36 it touched Friday. Crude oil is up 41% this year, with 31 percent of that rise coming in the past seven weeks alone. Oil declined by less than 1 percent in London trading after the U.S. said it would protect Middle East oil supplies by resisting any renewed Iraqi aggression toward Kuwait.

Faster inflation from higher oil prices poses a problem for bonds, said Xinyi Lu, chief strategist at Tokai Bank. He expects the 10-year Treasury yield to range from 5.7% to 6% in coming weeks, and notes repayable in less than five years to outperform bonds with longer maturities.

The surge in oil costs is prompting more selling of 30-year bonds, analysts said -- debt that is among the most sensitive to expectations of faster inflation. Investors are concerned high oil prices will spill over to other parts of the economy, causing companies to raise prices on their products containing crude.

While the stock market reacts to month-old economic data, the bond market looks to the month ahead. Last week's consumer price index data may have indicated that inflation dropped in August, but the bond market is not buying it. What's more, bond traders are seeing the same economic picture that we've already laid out for you. Rapidly rising oil prices will force companies to raise prices on oil-based products. Eventually, these price hikes will filter through the rest of the economy. Inflation is coming on strong and the outlook is not as rosy as Wall Street spin doctors would have you believe.
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