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Friday, June 08, 2007

The Short View By John Authers - The words "drama" and "Treasury bonds" do not usually go together.

The Short View By John Authers
Copyright The Financial Times Limited 2007
Published: June 8 2007 03:00 | Last updated: June 8 2007 03:00


The words "drama" and "Treasury bonds" do not usually go together. Yesterday was an exception.

The fall of US Treasury prices was greeted with horror by traders. The phrase is overused, but many thought yesterday's events marked the end of an era.

The rise in the 10-year Treasury yield - which underpins many securities in world capital markets - was about 17 basis points at midday in New York, the biggest leap in many years. There was no big economic data release or action from the Federal Reserve. This move was internally generated.

Further, the yield reached the level of 5.05 per cent. For bond traders, many of whom use technical cues, this was crucial. There is a 20-year trend of falling bond yields, as the world has steadily squeezed out inflation. Bond yields fluctuate, but each peak in the cycle for two decades has been progressively lower.

Until yesterday. The abrupt sell-off broke that trend line. The market implied yesterday that the era of stability and declining inflation is over.

What triggered this? Data for weeks have shown the US and world economies growing faster than thought. This week, the "bulge bracket" firms - Goldman Sachs and Merrill Lynch - abandoned their forecasts that the Fed would cut rates this year.

After taking stock, bond traders decided yesterday to sell.

Is this bad for stocks? Usually that depends on why bonds fell - inflation is bad for equities, growth less so. This is not about inflation, as index-linked bonds have barely moved.

What is worrisome is a possible third reason. Money just seems too cheap. Bond yields are not high by historical standards, but the suddenness of their move might dislodge the financing that underpins stocks. If that scenario turns out to be true - and it is still too early to say that it will - the bond sell-off might presage the end of an era for stocks.

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