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Treasurys rally on low consumer spending

January 16, 2008 | "Associated Press"

Government bonds up after data shows consumers cut retail spending during the holidays.

Treasury prices rallied sharply Tuesday after disconcerting news that consumers cut their retail spending in December, the month when stores almost always get a strong boost from holiday shoppers.

The buying spree drove the yield on the benchmark 10-year note to a nearly four-year low, as prices and yields move inversely. Falling yields are a classic signal that investors think the economy is unsteady and that the Federal Reserve will cut rates soon.

The Commerce Department Tuesday said retail sales dropped 0.4 percent last month. Although the result was in line with economists' predictions, it rattled markets because it suggests the consumer - one of the stalwarts of a faltering economy - is flagging.

"December was the worst showing for any December since at least 1991 and retail sales for the year were the worst year since 2002," said Tony Crescenzi, chief fixed-income analyst at Miller Tabak. "The weakness sharply boosts the likelihood that the U.S. economy entered recession in the fourth quarter, and it is almost indisputable now, the idea that the economy contracted in December."

Treasurys benefited from the news because they carry a safety premium and generally perform well when the economy is in danger and other assets seem risky. The report also contributed to a selloff in stocks, sharp declines for the dollar and higher gold prices.

The benchmark 10-year Treasury note shot up 21/32 to 104 18/32 with a yield of 3.69 percent, close to its lowest point since March 2004 and down from 3.77 percent late Monday.

The 30-year long bond gained 1 10/32 to 111 28/32 with a 4.29 percent yield, down from 4.36 percent late Monday.

The 2-year note rose 3/32 to 101 12/32 with a yield of 2.52 percent, nearly a three-year low and down from 2.55 percent.

The yield on the 3-month note edged down to 3.17 percent from 3.18 percent as the discount rate dropped to 3.07 percent from 3.10 percent.

The Fed's monetary policy committee's next meeting is Jan. 29-30. Fed Chairman Ben Bernanke has dropped heavy hints that a rate cut is quite likely. The worrisome fall in retail sales was seen as building a case for the Fed to cut rates by at least a 0.50 percentage point.

On Tuesday the Fed said it loaned $30 billion in four-week funds in the third (of four) auction operation designed to increase liquidity in a strained banking system. The funds were loaned at 3.95 percent, down from the 4.67 percent rate given at the most recent prior auction in late December. The lower yield implies that there was heavier demand this time.

The auctions, which are part of a concerted effort also involving the European Central Bank and the central banks of Canada, the U.K. and Switzerland, were announced in late 2007. The programs were created in response to concern that commercial banks were hoarding cash to shore up their strained balance sheets.
The problems of commercial banks were highlighted by Citigroup's (C, Fortune 500) new earnings report, which showed the bank's largest quarterly loss in its 196-year history, due to a $18.1 billion writedown for bad mortgage debt.

Citigroup's $10 billion loss is worst ever.

Other reports also pointed to economic weakness. The New York Federal Reserve's Empire State survey of regional manufacturing showed a drop to 9.03 this month from 9.80 in December.

However, there was some relief for the bond market in the form of inflation news. The bond market abhors inflation because it eats into the value of fixed income.
Producer prices fell 0.1 percent, according to the Labor Department. The result was smaller than the 0.2 percent drop expected by economists, but all declines in price pressure are generally good news. Excluding food and energy, producer prices gained 0.2 percent, matching expectations.

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