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Treasurys mixed on Fed worries

February 21, 2008 | "Associated Press"

Federal Reserve shows concern about impact of higher inflation and slower growth on economy; bonds are mixed on Fed meeting minutes.

Treasury prices were mixed Wednesday after minutes from the Federal Reserve's January meeting showed that officials are worried about weak economic growth.
Separately, the central bank dropped its 2008 growth forecast to a range of 1.3% to 2% from a range of 1.8% to 2.5%. The minutes from the Federal Open Market Committee's Jan. 29 to 30 meeting show that Fed governors are worried about how the economy will hold up this year amid higher inflation and slower growth.

But the most interesting aspect of the minutes, according to Action Economics, was that they revealed a previously undisclosed meeting on Jan. 9 at which committee members said there was potential for substantial rate cuts. In addition, the minutes show that some members believe recent rate cuts will need to be reversed once the economy rebounds.

The release of the minutes had only muted impact on a market that early in the session had sold off on news that consumer prices accelerated at a worrisome clip last month.

The benchmark 10-year Treasury note fell 2/32 to 96 24/32 with a yield of 3.90%, matching its late Tuesday level, according to BGCantor Market Data. Prices and yields move in opposite directions.

The 30-year long bond gained 6/32 to 95 23/32 with a yield of 4.64%, down from 4.67% late Tuesday.

The 2-year note dropped 2/32 to 100 2/32 with a yield of 2.09%, up from 2.08%.
Consumer prices rose by a seasonally adjusted 0.4% from December levels, according to the Labor Department. The core increase, which strips out volatile food and commodities prices, was 0.3%. Headline consumer prices were expected to rise 0.3% and core prices 0.2%, according to Thomson/IFR median estimates.
The rise in the core rate was the steepest since June, 2006 and exacerbated investor fears that a robust commodities rally has sent inflation spiraling throughout the economy. On Tuesday, crude oil futures had their first close above $100 a barrel.

The government bond market is highly sensitive to price trends because inflation dents the value of fixed income. So the consumer price report contributed to a sense of unease in the bond market that the Federal Reserve, in its efforts to stimulate battered capital markets and the housing sector, has grown lax about fighting inflation.

In theory, the news of rising consumer inflation could cause the Fed to rethink its current course of rate cuts, but analysts were skeptical this will happen. The central bank has lowered the overnight fed funds rate by 1.25 percentage points since the start of the year and signaled its willingness to make further reductions.
"The Federal Reserve seems incredulous to recent developments, continuously remarking that inflation expectations remain well anchored," said Tony Crescenzi, fixed income analyst at Miller Tabak.

"This does not fit with reality in light of the surge in commodity prices, surging import prices, the weakening of the U.S. dollar, rising consumer inflation-expectations, and recent consumer price data," he said.

Another data report showed that the housing market remains soft. The Commerce Department said that in January, housing starts rose by 0.8%, but only after plunging by a downwardly revised 14.8% in December. Building permits, a more forward-looking indicator, fell by 3%.

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