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Treasurys fall as rate-cut hopes dim

January 30, 2008 | "Associated Press"

Investors curtail expectations of a large Fed rate cut as 2-year yields creep higher. Fed announcement tomorrow.

Treasury prices mainly fell Tuesday, pushing short-term yields well above recent historic lows, as investors scaled back bets that the Federal Reserve will cut rates sharply this week.

The Fed's two-day monetary policy committee will culminate in an interest rate announcement Wednesday. After a hastily called special session last week, the central bank ordered an unusually large 0.75 percentage point reduction, driving the overnight Fed funds rate down to 3.5%.

The Fed also reiterated that it will take further steps, if necessary, to keep the financial system liquid. Initially Treasurys rallied sharply amid widespread expectations that another aggressive rate cut will be announced Wednesday.

Many investors still expect a reduction, but its magnitude is now in question. This is evidenced by the fact that 2-year Treasury yields have been creeping higher since last week, as some strong data reports have raised questions about whether a sharp rate cut is likely and necessary.

The 2-year yield is the most sensitive to monetary policy and its level provides clues as to where investors think rates are headed. The yield slid to a four-year low of 1.85% during last week's rallies. But it has risen 0.42 percentage point since then.

The 2-year note fell 13/32 to 99 23/32 with a yield of 2.27%, up from 2.20% late Monday, according to BGCantor Market Data. Prices and yields move in opposite directions.

The 10-year benchmark note slid 18/32 to 104 28/32 with a yield of 3.66%, up from 3.58% late Monday.

The 30-year long bond gave up early gains to close unchanged at 111 30/32 with a yield of 4.34%, up from 4.28% a day before.

The yield on the 3-month note fell to 2.22% from 2.27% late Monday as the yield on the discount note dropped to 2.17% from 2.22% late Monday.

An afternoon auction of $14 billion in 5-year notes attracted weak demand. The percentage of indirect bidders - a category that includes many foreign central banks - fell below that seen at the most previous sale of 5-year notes. On Monday a sale of 2-year notes also attracted weak interest from indirect bidders.

This week's auction results reinforce concerns that foreign central banks are backing away from dollar-denominated assets because sharp declines for the dollar have made them less attractive.

Strong data reports weaken the case that the Fed needs to cut rates aggressively to breathe new life into a battered economy. The Commerce Department reported that durable-goods orders surged 5.2% in December and upwardly revised November's level.

The gain was much larger than the 1.6% increase expected by Thomson/IFR. It could herald stronger business spending ahead as orders for items, such as airplanes and capital equipment, are a strong indicator of the business cycle.
But economists cautioned that last month's durable goods report may be closer to a one-off event than as a harbinger of future economic strength.

"A strong report, but it surely cannot last in the fact of the drop in activity reported by manufacturing surveys," said Ian Shepherdson, chief U.S. economist at High Frequency Economics. He noted that the most recent Philadelphia Federal Reserve survey showed extreme weakness in manufacturing.

Other new data showed consumers remain in a pessimistic frame of mind this month. The Conference Board's preliminary January consumer confidence index fell to 87.9 from a revised reading of 90.6 in December. However, Thomson/IFR had expected a weaker reading of 87.5, so the result was a bit above some analysts' expectations.

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