BOND REPORT

Treasurys prices wilt as stocks make headway

By Leslie Wines, MarketWatch

Last Update: 9:58 AM ET Aug 17, 2007

NEW YORK (MarketWatch) -- Treasury prices turned lower Friday, sending yields higher, as the stock market staged a boisterous rally in response to news report that the Federal Reserve cut the window discount rate by 50 basis points to 5.75% from 6.25%.

According to Action Economics, the reduction was made to narrow the gap with the overnight Fed funds rate, which remains at 5.25%. The discount rate is offered to some banks.

The move was a relief because it was seen as injecting extra liquidity into an anxious stock market. The Dow Jones Industrial Average ($INDU) rose more than 300 points in the first 10 minutes of trade. See Market Snapshot

"This certainly was a surprise, although there were rumors in the market yesterday that the Fed might do something," said Don Kowalchik, a fixed-income strategist at A.G. Edwards.

"Equity markets were rough overnight and I don't think the Fed wanted to see another bad day here," he said.

A number of foreign markets were rattled overnight, including Tokyo where the Nikkei 225 took its biggest beating in almost six years, as investors snapped up yen as they fled riskier currencies funded by carry trade yen loans.

Chart of $TNX

The benchmark 10-year Treasury note last was down 5/32 at 100-18/32 with a yield ($TNX) CBOE 10-Year Treasury Yield Index of 4.679%.

The 2-year note was flat at 00-24/32 with a yield of 4.193%

There was heavy selling of the 30-year bond, in a bid to deepen the distance on the yields of longer and shorter maturities. The long bond was 24/32 lower at 100-28/32 with a 5.008% ($TYX) CBOE 30-Year Treasury Yield Index.

Yield Curve-steepening trades trades tend to signal that traders anticipate higher inflation, according to. Kowalchik. He noted that the Fed continues to signal that it does not wish to push the fed funds target below 5.25% because of the inflation threat.

In its statement announcing the news, the Fed said the action would "promote the restoration of orderly conditions in financial markets."

Severely tightened credit conditions and weak liquidity have caused a number of recent severe selloffs in the stock market -- to the benefit of low-risk Treasurys.

Improved liquidity and higher stock prices on Friday could lessen demand for Treasurys.

Mike Englund, chief economist at Action Economics, cautioned that the move was "large symbolic."

"Most banks don't really borrow at the discount window rate," he said. "Basically it is just a facility for distressed banks."

"But the move is providing relief because it shows that the Fed is more focused on the liquidity problem than had been thought before," Englund said. "I think it is a brilliant move. It will appease those who want the Fed to do something and those who want it to do nothing." End of Story

Leslie Wines is a reporter for MarketWatch in New York.