Bullish Bond Market Trend Carries Cautionary Tone

Long-term interest rates keep sliding even as the Federal Reserve pushes short-term rates higher.

That's good news for the housing market, and it's helping the stock market as well.

But analysts worry that the trend is being driven by traders in U.S. Treasury bonds who are just in for a quick buck -- not unlike what happened with the frenzied buying of oil futures and the euro currency in recent months.

The lesson from the oil and currency markets was that, when too many speculators become convinced that a market will keep going the same way, it often stages a sharp reversal.

Long-term Treasury bond interest rates, or yields, are at their lowest level in months. But if bond yields were to snap back, so too could mortgage rates, which last week hit their lowest level since April. And stocks also could suffer.

For now, though, the bulls are in control in the bond market.

Long-term rates sank further Monday, with the yield on the bellwether 10-year Treasury note falling to a three-month low of 4.05%, down from 4.22% at the start of the year.

The 10-year T-note yield has dropped from 4.87% in June. The decline has occurred as the Fed has raised is benchmark short-term rate from 1% to 2.5% in six quarter-point increases since June 30.

Historically, it's unusual for long-term interest rates to slide in the early stages of a Fed credit-tightening campaign. And that's what troubles many analysts. They see something phony about the drop in bond yields.

Paul Calvetti, head of Treasury bond trading at Barclays Capital Inc. in New York, said short-term-oriented traders such as hedge funds have become big players in long-term bonds, riding the buying trend in recent months.

"It's a piling-on now," Calvetti said.

Traders, he said, are beginning to talk about the 10-year T-note yield falling below 4%. The confident tone about lower yields sounds a lot like discussions about oil in October, Calvetti said: Many traders were certain that crude would top $60 a barrel. Instead, oil peaked at $55 and has since pulled back to about $45.

If bond buyers suddenly were to shift gears and bail out, the turnabout could be dramatic.

That has happened twice in the last two years. Yields snapped back suddenly in the summer of 2003 and again in the spring of 2004. The yield on the 10-year T-note, for example, soared from 3.68% on March 16 of last year to 4.86% by mid-May.