A little dent may be in store, but economic fundamentals will eclipse capture.
December 14, 2003: 5:27 PM EST
NEW YORK (Reuters) - Saddam Hussein's capture in Iraq will likely dent U.S. Treasuries starting in Asia on Monday as investors flock to stocks, but the market should quickly return to the latest slate of economic data.
While the end of the hunt for Hussein is more clearly a positive for U.S. stocks and the dollar, the impact on Treasuries is a bit more mixed, analysts said.
Though a negative for safe-haven bonds if investors turn to stocks en masse, the capture could also lure more foreign funds back into dollar assets, including Treasuries.
Yet for all markets, the impact could be fleeting -- even for the dollar.
"Is this going to be a sustained story that defines things? Not really," said Alan Ruskin, head of research at 4Cast Ltd. in New York.
Instead, the market will glance at regional indexes of manufacturing activity to see how well the sector's big rebound is enduring in the final month of the year, while also looking at key gauges of inflation and capacity utilization -- two of the Fed's key guideposts for raising rates.
On Monday the New York Fed's Empire State manufacturing index will be released, while on Thursday the Federal Reserve Bank of Philadelphia's manufacturing business outlook survey is due.
Signs of continued robust growth in manufacturing, especially after the national Institute for Supply Management index hit a 20-year high in November, would likely send Treasuries into retreat.
But with the Federal Reserve wanting to see more evidence of improvement in the labor market, and capacity utilization putting more pressure on inflation, according to its October meeting minutes, Treasuries may hold firm through the end of the year.
Despite the hefty supply last week, the benchmark 10-year note fell to 4.24 percent, the middle of its broad 70-basis point range of the past five months, helped by the Fed's words. With the focus still on inflation, Tuesday's Consumer Price Index report would also be important for the market.
Economists polled by Reuters estimated the CPI rose 0.1 percent in November after a flat reading in October.
The core CPI, stripping out volatile energy and food prices, is also expected to be up just 0.1 percent after rising 0.2 percent in October.
Much attention will be paid to the year-over-year change in the core CPI, which last month edged up from a 37-year low to 1.3 percent.
Another rise in the core CPI would underscore that inflation had already hit bottom and was heading in the opposite direction.
But an unexpected decline, like that in the November Producer Price Index (PPI) that lifted Treasury prices on Friday, would reinforce the low-inflation backdrop.
Another focus for the market is the Federal Reserve's industrial production and capacity utilization data on Tuesday, as central bankers more explicitly link their policy moves to inflation and capacity use measures.
In its November policy statement, the Fed said with inflation "quite low and resource use slack," its accommodative policy can be maintained for a considerable period.
But the Fed also said the risks of inflation were more balanced now in what many viewed as a first small step toward an eventual hike in the current 1 percent federal funds rate.
"The Fed is focused on the output gap," said Sharon Lee Stark, managing director in fixed-income capital markets at Baltimore-based Legg Mason.
When Fed policy makers met in October, they said that expected growth for the next few years may not meaningfully reduce the output gap until late-2005 or even later. But Stark said the Fed could still lift its target rate.
"The Fed has a lot of stimulus in the system, and they know it. So step by step, they are preparing the market for taking out that phrase about maintaining accommodative monetary policy for a 'considerable period,'" said Stark, predicting fed funds would reach 2 percent by the end of next year.
"There's plenty of room for the Fed to raise the target fed funds rate while still maintaining an accommodative monetary policy," Stark said.
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