bonds opposing thoughts and likely outcome

bonds, opposing thoughts and likely outcome ...

the bond weakness today and during past days probably makes this report outdated already.

i do not believe berny will down rates to save the mortgage boom otherwise he'll achieve nothing. he wants the boom controlled and remortgaging made responsible. the bond mkt today suggests very definitely two more hikes. nov and (dec ?)

europe's got worried it's not acting fast enough.

stronger euro will help the dollar. dollar selling will give berny room to raise without that inevitable strong currency he wants to keep balanced. aimo.

i'm no expert. just the dummy in the classroom with my beano comic reading desperate dan. sometimes my ears pop up tho and i see things differently.

all very interesting stuff to say the least.

40


jolly bloomberg ...

What Fidelity Knows About Bernanke That Gross Doesn't (Update1)

By Michael McDonald

Oct. 23 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co., says Treasuries maturing in less than two years will lead a market rally next year as the Federal Reserve lowers interest rates.

George Fischer, who oversees $22 billion in debt at Fidelity Investments Inc., the world's largest mutual fund company, says short-term U.S. government debt will lose the most because the central bank, which meets this week, will keep rates unchanged, possibly through next year.

The conflict may explain why the biggest quarterly rally in four years is unraveling. Fund managers including Federated Investors say they are less convinced Fed Chairman Ben S. Bernanke will lower borrowing costs as soon as the first quarter of 2007. The latest government report showed stronger-than- anticipated job growth and a jump in consumer confidence.

``We're at a very odd point here in bond market history,'' Fischer said in an interview from his Merrimack, New Hampshire office. ``The Fed is being very clear that they do not want to ease soon, but the bond market is saying, `we know better.'''

Treasuries have declined 0.5 percent on average since September as Fed policy makers suggested inflation may not recede anytime soon, according to Merrill Lynch & Co. data. Even after the third-quarter rally, bonds have only gained 1.9 percent this year, the worst return since 1999, Merrill data show.

No Consensus

Yields on 4 5/8 percent notes due in 2008 were little changed at 4.87 percent last week. That's up from an eight-month low of 4.57 percent on Oct. 4. Two-year note prices tend to move with the central bank's target rate.

Ten-year yields, influenced more by perceptions of inflation, yielded 4.79 percent at the end of last week, and are up from a seven-month low of 4.53 percent on Sept. 25. They rose 3 basis points today to 4.82 percent.

Fed policy makers and will leave the target for overnight loans between banks unchanged at 5.25 percent when they meet Oct. 24-25 for one of their eight annual meetings, according to the median estimate of 80 analysts from an Oct. 11 Bloomberg survey.

Goldman Sachs Group Inc. and Merrill, two of the 22 primary dealers of U.S. government bonds that trade with the Fed, agree with Gross. They forecast the central bank will lower its target to 4 percent next year and that two-year notes will lead a rally. Merrill forecasts that yields on the debt will fall to 3.8 percent, while Goldman predicts 4.2 percent.

Strategists at Lehman Brothers Holdings Inc. and RBS Greenwich Capital Inc. say Fidelity is right. There is a growing likelihood the Fed will leave the overnight rate unchanged, further erasing the advances that pushed two-year note yields to eight month lows, they say.

`Very Long Period'

Fed Vice Chairman Donald Kohn warned investors on Oct. 4 not to underestimate the central bank's inflation concerns. He said he's more worried about a pick up in consumer prices than a slowdown in growth. ``Further upward movements in inflation would be very adverse to the economy,'' he said.

``The Fed is going to be on hold for a very long period of time,'' said David Ader, head of U.S. government bond strategy at RBS Greenwich Capital in Greenwich, Connecticut.

The last time the Fed held rates unchanged after a series of increases was May 16, 2000, through Jan. 3, 2001. During that period, when the overnight rate at 6.50 percent, 10-year notes gained twice as much as two-year securities.

Investors have earned 4.6 percent from 10-year Treasuries since June 29, when the Fed last raised rates, compared with 2 percent for two-year notes, according to Merrill data.

Real Estate Bubble

Shorter-term securities will provide the best returns as housing prices tumble, Paul McCulley, who oversees $100 billion in short-term investments at Newport Beach, California-based Pimco, said in an e-mail on Oct. 20. McCulley, who works with Gross, said the firm, a unit of Munich-based Allianz SE, forecasts the Fed will cut overnight rates as low as 4.50 percent next year.

The decline in home prices after a five year real-estate boom will cause the economy to slow and force the Fed to lower rates to avoid a recession, McCulley wrote on Pimco's Web site on Oct. 19. ``To think otherwise after a bubble is to not understand bubbles.''

Gross said in an Oct. 10 interview that he is most bullish on six- to 18-month Treasuries. He boosted his holdings of Treasuries and bonds of federal agencies to 12 percent in September, the highest since January. His $97 billion Total Return Bond Fund has gained 2.5 percent this year.

Fidelity's Fischer says inflation won't slow enough to prompt the Fed to reduce borrowing costs. Lower rates would also boost the housing market, he said.

Fed Minutes

The Fed's preferred inflation gauge, the personal consumption expenditures price index excluding energy and food, reached 2.5 percent in August compared with the year prior, the highest in a decade, the Commerce Department said on Sept. 29. The data for last month is scheduled to be announced Oct. 30. A Commerce Department report on Oct. 18 showed housing construction in the U.S. rebounded in September from a three- year low.

``The market is starting to get the sense that maybe the slowdown is not going to be as severe and the Fed is not going to ease as soon,'' said Donald Ellenberger, who oversees $5.5 billion as co-head of government and mortgage-backed securities group at Federated Investors in Pittsburgh.

The central bank on Oct. 11 released minutes from its Sept. 20 meeting that showed policy makers saw a ``substantial risk'' price pressures may not decline.

Interest-rate futures show that traders have reversed bets. On Oct. 4, the yield on the Eurodollar futures contract for September fell to a low of 4.73 percent, which suggested that the Fed would lower rates to at least 4.75 percent by the third quarter next year. Now it yields 5.07 percent, suggesting there may be just one cut by then.

Two-Year Notes

Fischer is avoiding two-year notes. Instead, he is buying 10-year Treasuries and securities maturing in less than six months. His $5.2 billion Fidelity Government Income Fund, which holds at least 80 percent of its assets in government securities, has earned 2.16 percent so far this year, according to Fidelity data.

``If you must buy, buy 10 years,'' said Amitabh Arora, head of U.S. interest-rate strategy in New York at Lehman Brothers. ``Do not buy the short end of the yield curve.''

To contact the reporter on this story: Michael McDonald in New York at [email protected] .

Last Updated: October 23, 2006 07:35 EDT