Bonds rally, but will the gains last?

Posted: Friday, March 26, 2004

NEW YORK (AP) So much for the bond market rally being last year's news.

The big gains that have been tallied in recent weeks have confounded the experts who track this market, and who had almost universally forecast just the opposite.

But doubts about the economy and concerns about terrorism have, along with technical factors, spurred the surprise surge in Treasury securities and taken yields down to near historic lows.

Now the question is whether this is just a temporary blip or a turnaround that will last.

The bond market made stunning gains last spring on expectations of that the Federal Reserve would keep interest rates low. That sent prices sharply higher and long-term Treasury yields which move in the opposite direction to prices sinking to 45-year lows in June.

But a pullback began last summer and was expected to continue in 2004. With the stock market and the economy both looking up, government bonds were looking less attractive to investors.

Up until a few weeks ago, that's exactly what was happening.

Then the Labor Department reported on March 5 that only 21,000 jobs were created last month. This was well below economists' forecasts and the fourth consecutive disappointing jobs report, and it convinced many investors that the Fed wouldn't raise interest rates anytime soon.

The yield on the 10-year Treasury note a benchmark for other long-term rates is now trading around 3.7 percent, its lowest level since last July.

Adding to the rally was a train bombing in Spain on March 11. Once reports linking the al-Qaeda terrorist network to the attacks surfaced, more money poured into the safety of bonds.

There has also been a turn in the stock market in recent weeks, with the major U.S. indexes coming under the steepest selling pressure in a year. That has some investors taking profits from their stock holdings, which have run up sharply in the last year, and putting money into more conservative bonds.

And those aren't the only things behind this rally.

The drop in long-term rates is producing yet another wave of mortgage refinancings. The Mortgage Bankers Association, a Washington-based trade group, said refinancing activity for the week ended March 12 reached its highest level in eight months.

That helps the bond market because it drives holders of mortgage-backed securities to load up on 10-year Treasurys, which they buy to hedge fluctuations in their portfolios caused by an increase in home refinancings.

Another big technical factor is continued foreign buying, largely from Asian central banks that are trying to hold down value of their currencies by purchasing dollars and then using those holdings to buy U.S. Treasurys.

But not everyone is convinced that the bond market's recent gains have staying power.

Morgan Stanley said in a note to clients last week that it was maintaining its recommended asset allocation, with 70 percent going to stocks and 30 percent in bonds. While acknowledging bonds have done better than expected, the investment firm believes the ''day of reckoning for fixed income still lies ahead.''

A similar view is shared by Milton Ezrati, the senior economic and market strategist at the money management firm Lord Abbett. He thinks the bond market has gone beyond where it should have and cautions investors against reading too much into this rally.

''Where we are right now puts the market in a vulnerable position to any sign of economic strength,'' Ezrati said. ''If the jobs number suddenly comes up, people could move out of this market very quickly like they did last summer.''

Should that happen, the outlook for interest rates could change, which could bump up long-term rates. And that could lead to a slowdown in home refinancings. Suddenly, much of what has been fueling this market could disappear.

Still, there is reason to not write this bond rally off just yet. This market has shown in the last year that there is really no telling what its next move may be.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)

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