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Bonds plummet on inflation warnings

February 20, 2008 | "Associated Press"

Investors worry about inflation as crude oil hits new record high - above $100 a barrel in mid-day trading.

Treasury prices fell in volatile trading Tuesday after a rally in the crude oil market touched off worries that inflation is spiraling.

Prices were uneven much of the day but turned decisively lower after oil futures shot to a new record above $100 Tuesday for the first time since the start of the year. There was no single driver behind oil's sharp price jump. But in the bond market it was viewed as a sign that an unusually durable commodities rally will unleash price pressure throughout the economy.

The bond market tracks price trends carefully and often sells off on signs of higher inflation, which erodes the value of fixed income.

The benchmark 10-year Treasury note fell 9/32 to 96 29/32 with a yield of 3.87%, up from 3.77% late Friday, according to BGCantor Market Data.

The 30-year long bond dropped 13/32 to 95 16/32 with a yield of 4.66%, up from 4.58% at the end of last week.

The 2-year note lost 4/32 to 100 5/32 with a yield of 2.04%, up from 1.92%.
The 3-month yield rose to 2.24% from 2.21% late Friday as the discount rate ticked up to 2.19% from 2.16%.

Fixed-income investors fear that recent heavy interest rate reductions by the Federal Reserve have put the economy on an inflationary spiral. The Fed has lowered the overnight fed funds rate by 1.25 percentage points since the start of 2008 and signaled that more rate cuts are being considered. There are worries that a central bank excessively focused on stimulating the economy has grown lax about inflation.

China's inflation hits 11-year high

The bond market has an ambivalent attitude toward rate cuts, which are considered positive because they cheapen the cost of money and stimulate market activity. At the same time, cheaper money generally produces higher prices over time and inflation erodes the value of fixed income investments.

"Traders are worrying more and more about inflation, especially when the Fed seems to be content with driving short-term yields lower and lower," said Kevin Giddis, managing director of fixed-income trading at Morgan Keegan.

The latest inflation concerns have left investors eager to view last month's consumer price report, which will be released Wednesday. According to Thomson/IFR, consumer prices should register a 0.2% January increase from December levels, when prices also increased by 0.2%.

The core rate, which is closely watched by the Fed and strips out food and energy costs, also should show a 0.2 month-over-month advance. If both the headline and core components are as expected, consumer-level inflation will remain well within the Fed's target range.

Although recent housing data reports generally have been extremely weak, a new survey Tuesday showed improving sentiment among home builders. The National Association of Home Builders sentiment index rose to 20 this month, up from 19 in January. The reading was in line with analysts' expectations.

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