Treasuries Fall as Minutes Suggest Fed in No Hurry to Cut Again

By Deborah Finestone and Sandra Hernandez

Oct. 13 (Bloomberg) -- Treasuries fell after minutes of the Federal Reserve's Sept. 18 meeting suggested policy makers are in no hurry to cut borrowing costs further.

Government data showing U.S. retail sales rose last month more than economists forecast added to investor expectations that the economy is weathering the housing slowdown, helping to send two-year notes to their biggest weekly loss since April. Reports next week are forecast to show consumer prices rose in September and housing starts fell to a 12-year low.

``We still feel the Fed will have to lower rates, but maybe not this year,'' said Laurie Carroll, bond index manager in Pittsburgh at Standish Mellon Asset Management, which manages $167 billion. ``Housing will be a lingering drag on the economy.''

The yield on the two-year note rose 14 basis points, or 0.14 percentage point, to 4.22 percent this week, according to bond broker Cantor Fitzgerald LP. It touched 4.23 percent yesterday, the highest since Aug. 28. The price of the 4 percent security due in September 2009 fell 1/4, or $2.50 per $1,000 face amount, to 99 19/32.

The last time the yield had a larger increase was during the week ended April 6, when the Labor Department reported that U.S. employers added more workers in March than forecast.

Yields on 10-year notes increased more than 4 basis points to 4.68 percent. Yields move inversely to bond prices.

The difference, or spread, between 10- and two-year note yields decreased to 47 basis points, the narrowest since the day before the Fed cut borrowing costs a half-percentage point to 4.75 percent.

Fed's Concerns

Minutes of the Fed's September meeting released Oct. 9 showed policy makers had no specific plan for further interest- rate cuts because they were unsure how markets and economic growth would respond.

Fed officials discussed concerns about layoffs at financial- services companies and the risk that declining home prices could hurt consumer spending.

The minutes also reinforced comments this month by Fed officials including Vice Chairman Donald Kohn that suggest the central bank hasn't committed to a series of rate cuts. Kohn said Oct. 5 that policy makers must be ``nimble'' in setting policy because of risks to both growth and inflation.

Retail sales advanced 0.6 percent in September after increasing 0.3 percent the previous month, the Commerce Department reported yesterday. The median forecast of 77 economists surveyed by Bloomberg News was for a 0.2 percent increase.

`Fresh Evidence'

``The problem for Treasuries is that for bonds to improve, we need to see fresh evidence of economic weakness, and we're not seeing that,'' said Kevin Flanagan, a Purchase, New York-based fixed-income strategist at Morgan Stanley's Global Wealth Management Group.

Futures contracts on the Chicago Board of Trade yesterday suggested a 34 percent chance that Fed policy makers will cut the target rate for overnight lending between banks a quarter- percentage point at the Oct. 31 meeting, compared with 40 percent odds a week ago.

``The market over-anticipated the Fed ease, and they have to rethink that,'' said Scott Peng, head of U.S. rates strategy in New York at Citigroup Global Markets Inc., one of the 21 primary securities dealers that trade directly with the Fed. ``The short end of the bond market could still continue to lead future sell- offs.''

U.S. stocks rose yesterday on the retail data, sending the Standard & Poor's 500 Index to a record high and its longest streak of weekly gains since May.

`Offset' Housing

``The bond market is respectful of the idea that a strong stock market could offset some of the housing market drag,'' said Michael Cheah, who manages $2 billion in bonds in Jersey City, New Jersey, at AIG SunAmerica Asset Management.

The Commerce Department probably will say on Oct. 17 that builders broke ground on 1.283 million homes at an annual rate in September, down from a 1.331 million pace the prior month, according to the median forecast of 62 economists surveyed by Bloomberg News.

The Labor Department may report the same day that consumer prices probably rose 0.2 last month after a 0.1 percent decrease in August, according to the median forecast of 68 economists surveyed by Bloomberg News. Annual inflation, excluding food and energy costs, was expected to remain at 2.1 percent, the lowest since March 2006.

Hedge-fund managers and other large speculators reversed from a net-short position to a net-long position in two-year note futures in the week ended Oct. 9, according to U.S. Commodity Futures Trading Commission data.

Treasury Longs

Speculative long positions, or bets prices will rise, outnumbered short positions by 17,169 contracts on the Chicago Board of Trade. Short positions last week outnumbered long positions by 4,707 contracts.

Volatility of Treasuries decreased to the lowest since late July. Merrill's MOVE Index, based on prices of over-the-counter options on Treasuries maturing in two to 30 years, fell to 82.40 on Oct. 11, the lowest since July 25, when a flight to safety boosted Treasuries as equity and credit markets slumped.

The two-year note's yield will decrease to 4.07 percent by year-end, according to a Bloomberg survey of 69 economists.

Last Updated: October 13, 2007 08:36 EDT