As if interest rates weren't low enough . . .

Uncle Sam is getting yet another break on his borrowing costs.

Suddenly, cash is again fighting to get into the haven of shorter-term Treasury securities, driving yields down to levels last seen after the first stage of the financial-system meltdown a year ago.

It may look like another fear-driven panic, but this time is different: In large part the latest decline in shorter-term yields just stems from moves by banks and other financial firms to bolster their balance sheets with highly liquid assets as 2009 ends, says Tom di Galoma, head of U.S. rates trading at Guggenheim Capital Markets in New York.

"They’re dressing up the books for year-end," he said. The more liquid you can look to your regulators, the better.

Late last year the hunger for Treasuries reflected a deep-seated dread that the financial system would continue to implode. That kind of sentiment is mostly absent this time around.

The annualized yield on three-month T-bills fell to a barely positive 0.01% on Thursday, down from 0.07% at the beginning of the week and the lowest level since last December.

The two-year T-note yield slid to 0.70%, compared with 0.81% a week earlier and also the lowest since December.

Traders said some T-bills were trading at slightly negative yields -- meaning buyers were in effect paying to keep their money in the securities, as opposed to earning a return on them.

Another factor pushing T-bill yields down: Growing demand is facing a smaller supply of new debt, as the Treasury winds down some of the deficit-financing programs that had pumped up T-bill issuance. The Treasury was selling as much as $33 billion a week in three-month bills in August. This week’s auction was for $30 billion.

Meanwhile, the Treasury continues to boost sales of longer-term securities.

As for the drop in the two-year T-note yield, that shows that buyers at these levels believe there’s no risk in locking in a yield of well under 1% on those securities. In turn, that implies growing faith that the Federal Reserve won’t be raising its benchmark short-term rate from near zero anytime soon -- maybe not even in the second half of 2010, which had seemed like a reasonable window for a Fed hike.

The view that the central bank could stay on hold for longer has been buttressed by recent comments from Fed officials including Janet Yellen, James Bullard and Chairman Ben S. Bernanke.

"Fed-speak lately has been pretty dovish" on rates, notes Jim Galluzzo, a Treasury trader at RBS Securities in Stamford, Conn.

Just what the short-term end of the Treasury market loves to hear.

-- Tom Petruno

Ron Paul wins a key battle in war to open Fed's books

Rep. Ron Paul, the Texas Republican who is perhaps the Federal Reserve’s most implacable enemy, scored a big win Thursday on Capitol Hill: The House Financial Services Committee approved adding to a financial-system reform bill Paul’s provision to begin federal reviews of the central bank’s operations, including its interest-rate decisions.

The vote on the audit provision amendment was 43-26.

Paul has for years asserted that the Fed, which by design is independent of  the federal government, was corrupt and that its monetary policy would drive America to ruin by debasing the dollar.

He has sought to abolish the Fed entirely, but because that almost certainly would never fly in Congress, Paul has worked for Plan B: He wants the Government Accountability Office to have full power to audit the central bank’s operations -- a measure the Fed bitterly opposes.

"If we get the audit and get the books open, make them answer the questions, I am convinced that the American people will be so outraged that then we will have reform of the monetary system," Paul has said.

Fed Chairman Ben S. Bernanke told Congress in June that Paul’s audit provision "would effectively be a takeover of policy by the Congress . . . [and] would be highly destructive to the stability of the financial system, the dollar and our national economic situation."

Paul contends that the Fed is overreacting. Here's how he describes what the provision would do:

--- Removes blanket restrictions on GAO audits of the Fed;

--- Allows the audit of every item on the Fed’s balance sheet, all credit facilities, all securities purchase programs, etc.;

--- Retains limited audit exemption on unreleased transcripts and minutes;

--- Sets a 180-day time lag before details of Fed’s market actions may be released;

--- Provides that nothing in the amendment should be construed as interference in or dictation of monetary policy by Congress or the GAO.

The audit-the-Fed measure is part of the financial-system-overhaul bill that the Obama administration has sought. It remains to be seen whether Paul’s Fed provision can make it through the full House and the Senate.

A note to clear up any confusion: The Obama administration wants the financial-overhaul bill, but it isn't clear that it would support the addition of Paul's audit-the-Fed provision.

-- Tom Petruno

Image: Ron Paul's latest book, "End the Fed"

Bernanke on bubbles: Nothing 'obvious' at the moment

Federal Reserve Chairman Ben S. Bernanke reiterated Monday that the central bank now knows enough to be worried about asset bubbles.

He just doesn't see any in the U.S. at the moment despite some investors' concerns about stock market valuations and the still-ravenous global appetite for Treasury securities.

In a Q&A session after a speech in New York, Bernanke at first channeled his predecessor, Alan Greenspan, on the subject of bubbles: Bernanke said it was "inherently, extraordinarily difficult to know whether an asset’s price is in line with its fundamental value or not."

And he added: "It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. financial system."

The Greenspan Doctrine was that it was too difficult for the Fed to know if a particular market was in a bubble (say, like housing in the mid-2000s) and that it was better for the central bank to leave markets to their own devices. We all know how that turned out.

Bernanke has made clear that the Greenspan Doctrine doesn’t rule the Bernanke Fed. Given the disaster wrought by the housing bubble, the Fed chief on Monday said that the central bank recognized the need to address the question of bubbles "in a serious way."

He said policymakers were "looking at various models of valuation for stocks, bonds and other kinds of assets" to judge their levels relative to the fundamentals.

As to whether the Fed would use higher interest rates specifically to prick a presumed bubble, Bernanke said that decision would have to be made in the context of the Fed’s two principal policy mandates -- promoting full employment and price stability.

If addressing "major misalignments of the financial markets" would further those policy goals, "We’d have to think about it very seriously," he said.

-- Tom Petruno

Photo: Fed Chairman Ben S. Bernanke speaking Monday at the Economic Club of New York. Credit: Mark Lennihan / Associated Press

Wall Street back in its groove as stocks and commodities surge, dollar sinks

The formula is working again: The seemingly incongruous combination of better-than-expected economic data and a falling dollar is driving the stock market to new one-year highs today.

The Standard & Poor’s 500 index has surged decisively through the 1,100 mark, which is where it had stalled in late October and again last week. If the S&P can hold its gains for the day the chart-watchers’ fear of a "double top" will be out the window.

The S&P was up 19.46 points, or 1.8%, to 1,112.94 at about 11:15 a.m. PST, amid a broad market rally. The Dow industrials were up 154.33 points, or 1.5%, to 10,424.

The government’s report on October retail sales was stronger than expected, and that helped fuel a rally at the opening bell.

But the best-performing market sectors are energy and raw materials -- a byproduct, once again, of a weakening dollar. The greenback is retesting last week’s lows against major currencies as global investors and speculators resume piling into higher-risk assets, using borrowed dollars for financing. That's the so-called carry trade.

The DXY index of the dollar’s value against six other major currencies was at 74.81 at about 11:15 a.m. PST, nearing last week’s 15-month low of 74.77.

As usual, gold is flying as the dollar sinks. The yellow metal is up $23.70 to a record $1,140 an ounce.

The buck briefly spiked higher today after Federal Reserve Chairman Ben S. Bernanke said in a speech in New York that the Fed was "attentive to implications of changes in the value of the dollar" -- an unusual comment, because the central bank typically pretends that it doesn’t worry about the U.S. currency, deferring that concern to the Treasury.

But currency traders saw no hint in Bernanke’s comment that the government will do anything more than talk about the dollar as it slides.

"In the absence of any notable shift on the policy front we doubt that ‘official’ jawboning can do much to reverse the current weak dollar trend," Vassili Serebriakov, a currency strategist at Wells Fargo & Co., said in an e-mail.

-- Tom Petruno

 Photo credit: Jin Lee / Associated Press

The Fed's 'road map' to higher interest rates

The Federal Reserve made clear Wednesday that it isn’t planning to raise short-term interest rates soon.

But the central bank also got more specific about the conditions that would spur it to lift its key rate from the current zero-to-0.25% range.

Here’s how the critical paragraph in the Fed’s post-meeting statement reads:

"The Committee will maintain the target range for the federal funds rate at 0 to 0.25% and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

The bolded type is what was added to that paragraph since the Fed’s last meeting on Sept. 23.

"In citing these three conditions, the Federal Reserve has provided a road map by which market participants can gauge with greater precision the evolution of monetary policy, in particular the exit strategy for the Fed’s current stance," Tony Crescenzi, a bond market strategist at Pimco in Newport Beach, wrote in a note to clients.

"This will make the implementation of the Fed’s exit strategy more a process than event," Crescenzi said. "It will also give the Fed an ‘out’ because incoming data related to the three conditions mentioned will take on greater weight than the Fed’s own words, allowing the Fed to simply rubberstamp the conclusions drawn by market participants regarding the incoming data."

The first condition mentioned -- "resource utilization" -- could apply to both labor and factory capacity, both of which are severely underutilized at the moment. No debate there. Even if the economy keeps expanding, the Fed is saying that it wants to see labor and industrial slack taken up before it will think about tightening credit.

To measure whether inflation trends are "subdued," the Fed presumably would rely on the government’s major inflation gauges, including the consumer price index and the so-called personal consumption expenditures price index. The year-over-year gains in the "core" indexes of those gauges were 1.5% and 1.3%, respectively, in September, which in both cases would qualify as "subdued."

To measure whether inflation expectations are "stable," the Fed could look at future price increases implied by interest rates on Treasury inflation-protected bonds, and at trends in gold prices and the dollar.

Crescenzi noted that the Fed’s statement specifically referred to longer-term inflation expectations as being "stable" at the moment.

But are they?

"It is intriguing that the Fed would label inflation expectations ‘stable’ when the amount of inflation expectations embedded in 10-year inflation-protected Treasuries reached its highest point of the year -- 2.14%, indicating that 10-year inflation-protected Treasuries are priced for the consumer price index to increase at a 2.14% [annualized] rate over the next 10 years," Crescenzi said.

Gold, hitting record highs this week, also could be signaling rising inflation expectations. But gold’s new bull run also could be pointing to something more visceral -- increased distrust of all paper currencies -- rather than heightened concern about inflation.

-- Tom Petruno

Post-Fed scorecard: Gold at new high, other markets slide

Gold’s latest rally powered ahead Wednesday as the Federal Reserve maintained a dovish attitude toward interest rates.

Meanwhile, the dollar, the stock market and longer-term Treasury bonds all sold off after the Fed issued its post-meeting statement, which repeated that policymakers expected to keep short-term rates low "for an extended period."

Near-term gold futures gained $2.40 to $1,086.70 an ounce, a new record closing high that lifted the year-to-date price gain to about 23%. The metal traded as high as $1,098.50 for the day, after surging nearly $31 on Tuesday on word of the Indian central bank's big purchase.

Not surprisingly, the likelihood of the U.S. maintaining near-zero short-term interest rates was a negative for the dollar, which helped bolster the case for gold. The euro jumped to $1.487 from $1.472 on Tuesday.

The stock market, which rallied early in the day on some relatively upbeat economic data, surrendered most of its gains in the final 30 minutes of the session -- a decline some analysts blamed on the U.S. House’s vote to speed up new limits on credit card interest rates. That slammed bank stocks. The Dow industrials closed up 30.23 points, or 0.3%, to 9,802.14, after being up as much as 156 points.

Some investors also dumped longer-term Treasury bonds post-Fed. The 30-year T-bond yield jumped to 4.40%, up from 4.33% on Tuesday and the highest since Aug. 14.

On the face of it, the markets might seem to be worried about the Fed falling behind the curve in keeping inflation subdued -- except, where do you find inflation these days, other than in asset prices? (OK, oil is a problem again lately, that is true.)

Nicholas Colas, investment strategist at BNY ConvergEx Group in New York, thinks the stock market’s disappointing action is just another sign that "it’s definitely in need of a breather here." Stocks have been struggling since peaking in mid-October as more investors have turned cautious about the near-term economic outlook.

The Standard & Poor’s 500 index, which edged up 0.1% on Wednesday to 1,046.50, is down 4.7% from its one-year closing high of 1,097.91 on Oct. 19.

"The biggest single question is, how are consumers thinking about their prospects going into Christmas?" Colas said. People may think better about their prospects if they have more faith that job cuts are ebbing -- which is why the government’s report Friday on October employment trends will be key, as usual.

As for the sell-off in the bond market, traders noted that the Treasury on Wednesday gave more details about its plan to lengthen the average maturity of the government’s debt load, which of course means issuing more longer-term debt and fewer shorter-term securities. That may have triggered some knee-jerk selling of longer-term bonds.

As I noted in this post, the trend no one would want to see take hold this month (or any month) would be rising bond yields accompanied by falling stock prices. Just something to watch.

-- Tom Petruno

Photo credit: Genaro Molina / Los Angeles Times

Fed keeps 'extended period' pledge on low rates

Federal Reserve policymakers stayed with the status quo today, saying in their post-meeting statement that they expected to keep short-term interest rates low "for an extended period."

That had been the big mystery surrounding the Fed’s meeting -- whether Chairman Ben S. Bernanke and peers would feel compelled to signal that the improving economy would lead to tighter credit sooner rather than later.

By retaining the "extended period" pledge, the Fed is offering no incentive for markets to push up short-term rates on their own.

One change of note in the statement: The Fed will pare back on purchases of bonds issued by mortgage giants Fannie Mae and Freddie Mac, citing "the limited availability" of such debt. The change doesn’t affect the Fed’s larger purchase program of mortgage-backed securities, which is the direct way it is attempting to keep mortgage rates down.

Here is the text of today’s meeting statement, followed by the text of the statement from the Fed’s Sept. 23 meeting, for comparison:

Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period. Activity in the housing sector has increased over recent months. Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.

The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

The Sept. 23 meeting statement:

Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009.

The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

-- Tom Petruno

Why the 'disconnect' between the economy and your 401(k) could persist

The stock market has a serious lot working against it at the moment: fresh doubts about the economic recovery, a rebounding dollar and the general sense that share prices are overdue for a pullback after a nearly eight-month-long advance.

Including Friday's slump, the Standard & Poor's 500 index is off 5.6% from its one-year high reached Oct. 19, and talk of a bigger drop is rampant (again).

But if institutional investors remain reluctant to sell equities, it's because they see that plenty of companies are looking better than the U.S. economy as a whole.

How is that possible? In my weekend column in the Times, I note how corporate balance sheets have improved this year thanks in part to the plunge in long-term borrowing costs -- which has been abetted by small investors' ravenous demand for bonds.

Wall Street also can't ignore the turnaround in corporate earnings, even though the bottom line has been fattened largely because of vicious cost-cutting at workers' expense.

Why is the U.S. still losing jobs? As economist Allen Sinai put it: Companies are "making good money without people."

That isn't a path to long-term prosperity, but remember: Many major American businesses (the kind you probably own in your 401[k]) are betting on faster growth abroad than at home, anyway. And their biggest investors, for the most part, don't care where in the world they make money, as long as they make it.

I also note in the column that, as long as doubts persist that the U.S. economic recovery can sustain itself, the Federal Reserve (which meets this week) will remain in a supporting role with near-zero short-term interest rates.

And with "cash" investments paying nothing, and long-term bond yields low, it's that much harder for investors to bail on stocks en masse.

So, could the market pull back further this month? No question. That would surprise virtually no one.

But could we face another crash that obliterates your 401(k)? Highly unlikely in the near term.

Read the full column here.

-- Tom Petruno

Blowout Treasury note sale shows no fear of Fed

Cancel those worries about investor indigestion in the Treasury bond market, at least for today: The government’s auction of a record $44 billion of two-year notes was a blowout, as buyers bid aggressively.

That has triggered a rally across the board in Treasuries, driving yields lower after their uptrend in recent days.

The two-year T-notes were sold at an annualized yield of 1.02%, compared with an expected yield of 1.05% in a Bloomberg News survey of bond dealers.

Investor bids totaled $3.63 for every $1 in notes offered, a huge increase from the average $2.77 in bids per $1 offered at the last 10 auctions of two-year notes.

Ian Lyngen, a government bond strategist at CRT Capital Group in Stamford, Conn., called it a "very strong auction."

Robust demand for the notes suggests many investors don’t believe the Federal Reserve will be raising short-term interest rates anytime soon. That sentiment was reinforced today by the latest dismal report on consumer confidence.

The Treasury will auction $41 billion of five-year notes on Wednesday and $31 billion of seven-year notes on Thursday as it continues to borrow record sums to finance the federal deficit.

The 10-year T-note yield, a benchmark for mortgage rates, has pulled back to 3.47% today from 3.55% on Monday.

Falling Treasury yields could help California, which today launched a sale of at least $3 billion in tax-free bonds to refinance previously issued "economic recovery bonds" -- the debt voters authorized in 2004 to bail the state out of that year’s budget mess.

-- Tom Petruno

 

Beware the toxic mix of falling stocks and rising Treasury yields

Stocks slumped Monday and Treasury bond yields rose, which is a combo that really gives Wall Street the creeps.

The damage was limited -- the Dow Jones industrials lost 104.22 points, or 1%, to 9,867.96, and the 10-year T-note yield (charted below) ended at 3.55%, up from 3.47% on Friday. But if this turns into a trend it could undermine investor confidence in a hurry.

Why? Stocks, of course, are a bet on economic recovery. If the market sells off because of recovery concerns, Wall Street fully expects Treasuries to benefit -- meaning, yields should fall as some investors seek a haven.

Unless . . . investors stop regarding Treasuries as a haven, perhaps because of the ever-ballooning federal debt.

Investor demand for Treasuries had been robust in August and September even as the stock market rallied. But for the last seven months the Treasury market also has had the benefit of regular purchases by the Federal Reserve, which on March 19 committed to buying $300 billion of government bonds in an effort to put a lid on longer-term interest rates.

Those purchases will end this week as the Fed reaches its self-imposed $300-billion limit.

While the Fed prepares to step away the Treasury is coming to market with another huge slate of debt to sell: It will auction $44 billion of two-year notes today, $41 billion of five-year notes on Wednesday and $31 billion of seven-year notes on Thursday.

It isn't unusual for market yields on Treasuries to back up a bit ahead of auctions. That may be the simple explanation for the recent rise in interest rates, which left the 10-year T-note yield at a two-month high on Monday.

George Goncalves, head of fixed income rates strategy at bond dealer Cantor Fitzgerald in New York, thinks there's still enough private investor demand for Treasuries to soak up the ongoing flood of supply without a steep jump in yields.

Some big investors, he says, have been simultaneously putting money to work in the bond market at opposite ends of the spectrum: They've been buying corporate junk bonds for yield, while also buying Treasuries for the liquidity they should provide if markets were to enter another panic phase.

But Tom Tucci, head of government bond trading at RBC Capital Markets in New York, says a lot of the investors his firm deals with aren't much interested in Treasuries at current yields, which are well below their peak levels of spring.

"With people now very neutral on the market given where yields are, supply becomes an issue again," Tucci said. And the Fed won't be there after this week to take up some of that supply.

Wall Street can understand the logic of the combination of falling stock prices and falling Treasury yields; ditto for the combo of rising stock prices and rising bond yields.

But in a still-struggling economy, falling stocks and rising Treasury yields would signal that something has gone very wrong.

-- Tom Petruno