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As Treasury yields rise, Wall St. wonders how much to worry

May 30, 2008 |  5:00 am

Investors who bought U.S. Treasury bonds in the last few weeks are having a bad case of buyer's remorse: Yields in that market keep rising and this week crossed some important thresholds.

The yield on the 10-year T-note, for example, has jumped above 4% for the first time since the beginning of January. It reached 4.08% on Thursday, up from 3.33% in late March. That's a big move for a 10-week span. Today the yield eased to 4.05%.

Treas10year

Wall Street, however, isn't quite sure how worried it should be about the turnabout in bond rates. Some part of the rebound is a welcome return to normalcy after the financial-system-meltdown scare of mid-March (the Bear Stearns debacle), when investors rushed into Treasuries for safety.

But there also is a gnawing fear among bond market pros that the Treasury market is playing the coal-mine canary role on inflation: meaning, investors are demanding higher fixed yields on Treasuries to compensate for their concern that inflation will contine to rise and ultimately force the Federal Reserve to begin tightening credit.

Given $130-a-barrel oil, "I think the notion of inflation taking root now is a global concern," said T.J. Marta, fixed-income strategist at RBC Capital Markets in New York.

Global indeed: Government bond yields in Europe and Japan also have shot up in recent weeks. The 10-year German government bond yield hit 4.43% on Thursday, the highest since last fall.

At the same time, though, yields on riskier bonds -- such as U.S. corporate junk issues -- have risen only modestly this month. The yield on an index of 100 junk issues tracked by KDP Investment Advisors was 9.30% on Thursday, up from 9.12% on May 1 and down from 10.16% in mid-March.

That suggests that some investors who have exited Treasuries have moved their money into riskier securities. That's exactly what the Fed has been hoping to see, as a sign of faith in the wobbly economy. Meanwhile, mortgage rates have edged up as Treasury yields have climbed, but at 6.08% this week the average 30-year home loan rate remains below its mid-March level of 6.13%, according to mortgage giant Freddie Mac.

With the Fed holding its benchmark short-term interest rate at 2% some bond market analysts say Treasury yields have backed up enough for now. "I think the market has hit levels where it's attracting buyers," said Brian Edmonds, head of interest rates at bond dealer Cantor Fitzgerald in New York. A rush of money came into the market when the two-year T-note yield reached 2.75% on Thursday, he said. Today the two-year T-note slipped to 2.64%. It was 2.24% three weeks ago.

Still, if the core inflation rate (the one that excludes food and energy) begins to bust out from the current 2% range, Treasury yields at these levels would look mighty paltry. That could mean we ain't seen nothin' yet in terms of how quickly investors might seek to unload Uncle Sam's paper.

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