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A big downside of rising yields

Investors' flight from U.S. bonds bodes ill for the housing market.

June 11, 2008|Tom Petruno | Times Staff Writer

The Federal Reserve hasn't raised its benchmark short-term interest rate, but it might as well have judging from the way the Treasury bond market is acting.

And that is a distressing turn of events for the struggling housing market.

Yields on Treasuries have been in an upward trend since mid-March, and the trend accelerated in the last few days as investors bailed out of government obligations. The yield on the two-year T-note ended at 2.92% on Tuesday, up from 2.71% on Monday and 2.38% on Friday.

A move of half a percentage point in two trading sessions is nearly unheard-of.

"This is the get-me-out trade," said Tom di Galoma, a veteran bond trader at brokerage Jefferies & Co. in New York.

Why the sudden urge to sell? The Fed seems to have gotten religion about inflation pressures in the economy, with oil's surge above $130 a barrel. Chairman Ben S. Bernanke warned about the risks of higher inflation in two speeches over the last week.

The implicit message: Don't expect the central bank to make another cut in its benchmark rate, now 2%. In fact, be prepared for a rate hike, particularly if oil doesn't come down.

That is driving two camps of investors away from bonds. Camp One comprises "people who had been betting on a weakening economy," Di Galoma said. Bernanke, in his speech Monday, indicated that the Fed was less concerned about the economy than about inflation.

Camp Two: Investors who figured the Fed was done cutting rates but who believed a rate increase wouldn't happen before 2009. Now, the concern is that Bernanke might want to start tightening credit in the fall.

David Ader, chief government bond strategist at RBS Greenwich Capital in Greenwich, Conn., still expects the Fed to wait until next year to raise its key rate. But with its new hard line on inflation, he said, "The Fed is trying to tighten credit without actually tightening."

Many on Wall Street believe Bernanke's remarks and comments earlier Monday by Treasury Secretary Henry M. Paulson Jr. were designed in part to pull oil prices down by lifting the dollar. A stronger greenback could reduce global investors' and speculators' appetite for commodities.

And commodities indeed sank Tuesday as the dollar rallied.

"What Bernanke has done to U.S. yields has given the dollar a lot more support than anything else he could have said," said Daniel Katzive, a foreign exchange strategist at Credit Suisse in New York.

But rising bond yields are about the last thing the crippled housing market needs.

The mortgage market takes its cue from longer-term Treasuries. Although their yields haven't risen as quickly as shorter-term yields, the 10-year T-note, at 4.11% on Tuesday, was the highest since Dec. 27.

That could mean more upward pressure on mortgage rates.

The average 30-year loan rate was 6.09% as of last week, up from 5.98% two weeks earlier and the highest since mid-February, according to mortgage finance giant Freddie Mac.


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