Robust 30-year auction inverts curve

[Scubawarrior]

 
NEW YORK (MarketWatch) -- The complete inversion of the yield curve on Friday, which pushed the interest rate of the 2-year Treasury note above the rates paid by the 10-year note and the 30-year long bond, reignited a debate as to whether a recession is ahead.



The steep inversion was one factor for the morning sell-off in U.S. equities, strategists said. See Market Snapshot.
A yield inversion effectively destroys the incentive for making longer-term loans. Historically, it has been viewed as a sign of lack of investor confidence in the nation's long-term economic prospects and a harbinger of recession.

But government officials, including Treasury Secretary John Snow and former Federal Reserve Chairman Alan Greenspan, have insisted that the inversion now reflects boisterous global appetite for U.S. assets, rather than deteriorating U.S. economic fundamentals.
New Fed chief Ben Bernanke attributes the inversion to a global savings glut that has sent unprecedented flows of capital from all over the world to U.S. Treasurys.
The yield curve between the 2-year and 10-year maturities inverted for the first time in five years in late December, and has recurred a number of times in early 2006.
The last time the yield curve inverted was in 2000, before the last U.S. recession and a period of aggressive rate cuts by the Federal Reserve. The yield curve briefly inverted in 1998 during the Asian financial crisis -- the only time in the past 30 years that an inverted yield curve has not preceded a recession.
Thursday's highly successful auction of $14 billion in 30-year benchmark bonds, which attracted an unusually large bid by foreign institutions and U.S. institutional investors, exacerbated the phenomenon. See full story.
The intense demand for 30-year bonds on the part of insurers and companies and governments with heavy pension-funding needs led to unexpectedly high prices, pushing the long bond's yield below expectations even as shorter-term yields climbed higher.
Market impact
The inverted curve and the possibility of a slowdown ahead rattled equities investors Friday.
"Traditionally, [the inversion] would indicate that we are headed for trouble," said Peter Cardillo, chief equities strategist at S.W. Bach. "I have not come to the conclusion we are headed for a recession, but I am a little worried."
Other analysts pointed out that destroying the incentive for making long-term loans will have negative consequences, even if the inversion doesn't stem from deteriorating economic conditions.
Tom Girard, senior portfolio manager at Weiss Peck & Greer, said that he doesn't believe the inversion signals a recession, which is a long-lasting and broad-based contraction in the economy.
However, some slowing due to the upside-down state of yields is inevitable, in his view.
"It will become more and more difficult for financial institutions to make money," Girard added. "So it will be harder for banks to be aggressive in making loans." See the day's interest rates.
Michael Englund, chief economist at Action Economics, said that the development may not be that worrisome, as his institution is yet to see a yield curve inversion on a monthly averaged basis.
Other economists also characterized the inversion as a temporary, technically induced phenomenon.
"We have classic full inversion," said Anthony Karydakis, chief economist for J.P. Morgan Asset Management. "I don't think it means very much. This time, it should not be viewed as a predictor of future economic activity.
"This is a technical inversion," he added. "There are special factors at work in the long end of the market."
Although analysts differed about the economic implications of the inversion, they agreed that the market was trying to send a loud and clear message to the Federal Reserve.
"The implications are a bit worrying for spreads, particularly for the corporate market," said David Goldman, head of fixed-income research at Cantor Fitzgerald. "The inversion means the market thinks the Fed has tightened too much and expects short-term rates to be cut by the Fed."
For his part, chief economist for North America at Merrill Lynch David Rosenberg said: "It is telling the Fed that you, folks, may well take the funds rate up to 5% or higher, but it ain't staying there."
On Friday Treasury prices were higher in morning trading, sending yields down. But prices turned lower in afternoon action, sending yields a bit higher, although the curve was still inverted.
The benchmark 10-year yield last was down 5/32 at 99 15/32 with a yield ($TNX : CBOE 10-Year Treasury Yield Index
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Last: 45.81+0.40+0.88%

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$TNX45.81, +0.40, +0.9%) of 4.568%, placing it above the 4.527% yield ($TYX : CBOE 30-Year Treasury Yield Index
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$TYX45.47, -0.96, -2.1%) of the 30-year bond, but below the 2-year note's 4.673% yield. See Bond Report.
In opening trading, the 30-year bond was yielding 4.47%, meaning that an investor could get a bigger return on lending money overnight than for 30 years.
Completing the picture, the yield on the 6-month Treasury bill was higher than the 2-year yield, standing at 4.695%.
Rex Nutting contributed to this story from Washington.
Leslie Wines is a reporter for MarketWatch in New York.