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Bonds fall on Countrywide buyout rumor

January 11, 2008 | "Associated Press"

Report that Bank of America could buy the lender and Fed Chairman Bernanke's talk of rate cuts may be the mortgage crisis' light at the end of the tunnel.
Treasury prices fell sharply Thursday after stocks advanced on news that Bank of America (BAC, Fortune 500) might buy struggling mortgage lender Countrywide Financial Corp (CFC, Fortune 500).

The news was viewed as a sign that troubles in the hard-hit mortgage and housing sectors may be contained soon. The sense that economic relief may be imminent was furthered when Federal Reserve Chairman Ben Bernanke indicated the Fed is very likely to cut rates again.

The Fed chief said the central bank was prepared to act aggressively to rescue a weakening economy. "We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks," he said.

Initially, both the Treasury and stock markets rallied on the news, but the Treasury gains evaporated as investors decided to concentrate their buying in equities. Although investors are eager to see cheaper money, the fact that the economy needs a great deal of stimulation from the Fed is a concern.

In late 2007 the Fed cut rates by a full percentage point. Its monetary policy committee will meet on Jan. 29-30.

Ian Shepherdson, chief U.S. economist at High Frequency Economics, agreed. "Clearly, there are more rate cuts to come and [half a percentage point] looks increasingly likely," he said.

The benchmark 10-year Treasury note fell 17/32 to 102 31/32 with a yield of 3.87 percent, up from 3.83 percent late Wednesday, according to BGCantor Market Data.

The 30-year long bond dropped 1 25/32 to 109 3/32 with a yield of 4.44 percent, up from 4.35 percent late Wednesday.

But the 2-year note gained 1/32 to 101 1/32 with a yield of 2.70 percent, down from 2.73 percent late Wednesday.

The yield on the 3-month note rose to 3.26 percent from 3.21 percent late Wednesday as the discount rate rose to 3.18 percent from 3.13 percent.

Bernanke's remarks were a relief to investors confused about the Fed's intentions.

The meeting notes from a December monetary policy meeting at the Fed made clear that the committee members were deeply divided about the 0.25 percentage point rate cut put in place then. Some members wanted a larger cut, while others thought the Fed should take no action. This muddied the outlook for the upcoming meeting.

A large amount of new corporate and foreign bond issuance Thursday also limited demand for Treasurys. New deals coming to market include a $4 billion three-tranche offering by UPS, $1 billion in 3-year notes from Nordic Investment, a $400 million offering by Florida Power and $300 million in 10-year notes from Emerson Electric.

Since the start of 2008 the Treasury market has been pricing itself for a recession and for expected rate cuts. Numerous sharp rallies have pushed yields on the 10-year and 2-year notes to their weakest levels in about three years.
Lower yields are a classic sign that investors expect the Federal Reserve to cut the overnight Federal funds target for loans to commercial banks. The Fed's next monetary policy meeting is on Jan. 29-30.

There was only limited response to a report that weekly jobless claims in the latest week dropped by 15,000 to 322,000. The unemployment report for December showed a rise in the unemployment rate and left many economists convinced that a recession is in the works, even if there are improvements in weekly data reports.
However, the Treasury market carefully monitored weak new retail sales reports from Target Corp. and others. Consumers have long been one of the engines of the economy. If they slow their spending, economic weakness is likely to worsen.
An afternoon auction of $8 billion in new 10-year Treasury Inflation Protected Securities attracted weaker-than-expected demand from foreign bidders and just average domestic interest. The sale had been expected to go well as investors increasingly are focused on rising inflation, given recent sharp gains in prices of many commodities.

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