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Bonds rise as Merrill hits stocks

January 14, 2008 | "Associated Press"

Prices climb as investors sell equities on reports that Merrill Lynch will write down $15 billion more in subprime-related debt.

Treasurys rallied Friday, benefiting from a steep stock market selloff sparked by worries that Merrill Lynch & Co. (MER, Fortune 500) may have to write down an additional $15 billion in bad mortgage debt.

The stock and bond markets often trade in opposite directions. On Friday the less risky Treasury market drew support from growing wariness about financial and other stocks ahead of earnings reports next week. The session marked a reversal from the one the day before when Wall Street advanced sharply and Treasurys plunged on rate cut expectations.

"There has been a lot of volatility this week," said Mirko Mikelic, a fixed-income portfolio manager at Fifth Third Asset Management. "There are a lot of concerns about the economy." In general fears about economic softness spark demand for Treasurys, which carry government-backing

The benchmark 10-year Treasury note rose 19/32 to 103 19/32 with a yield of 3.81 percent, down from 3.88 percent late Thursday. Prices and yields move in opposite directions.

The 30-year long bond advanced 24/32 to 109 31/32 with a 4.39 percent yield, down from 4.45 percent.

The 2-year note gained 5/32 to 101 8/32 with a yield of 2.59 percent, down from 2.68 percent.

The yield on the 3-month note dropped to 3.11 percent from 3.88 percent Thursday as the discount note fell to 3.04 percent from 3.18 percent.

Treasurys were up-ended Thursday when an unusually candid Federal Reserve Chairman Ben Bernanke all but promised that the central bank will reduce rates to stimulate the economy this month. Although the market would like to see cheaper money, Bernanke's depiction of a faltering economy was worrisome.

Bernanke's almost-pledge of a rate cut has serious negative implications for the bond market because cheaper money stimulates inflation, said Don Kowalchik, a debt strategist at A.G. Edwards. The bond market is wary of inflation because it reduces the value of fixed income.

"Once money becomes cheaper, corporate America tends to borrow and spend more," Kowalchik said. "And that makes the economy perform better, which often creates inflation."

In other worrisome news for the government bond market, Moody's Investors Service Thursday warned that the U.S. is in danger of losing its stellar "AAA" credit rating within the decade.

The ratings agency warned that the U.S. must curb its healthcare and Social Security spending to avoid a lower rating. The U.S. has enjoyed the highest rating since it was first assessed by Moody's in 1917.

There was limited market reaction to new economic data. The Commerce Department reported that higher energy prices drove the nation's trade deficit in November to its highest level in more than a year.

The government said the gap shot up 9.3 percent to $63.1 billion, the widest since September 2006 and up from $57.8 billion in October. Economists surveyed by Thomson/IFR Markets forecast a trade gap of $58.6 billion.

Separately, there was good news on inflation in December, when import prices were unchanged, the Labor Department said.

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