Market hurt by growth signs; observers fear rally is at an end.

Is the party over in the Treasury market?

After donning a party hat and popping champagne bottles for several months, the market has woken up to the sobering reality of stronger economic growth. And according to some market observers, the headache for fixed-income investors may have only just begun.

They point toward what they see as compelling signs of growth in the economy and their belief that falling interest rates abroad will boost U.S. exports.

The bond closed down for the third session in a row Monday, to yield 5.99%.

Market participants are hedging their optimistic assessments of the economy somewhat, noting that economic activity is far from booming and that job growth remains a trouble spot. They agree, however, that there are too many signs of strength in the economy to ignore.

"The market is finally realizing that the economy is improving," said Michael Strauss, chief economist at Yamaichi Securities. "All indications show that the cyclical decline in interest rates is over."

Strauss and other market economists pointed toward improvement in consumer spending, housing activity, the trade deficit, and a pickup in consumer loan activity as evidence that the economy is not as weak as the bond market had priced in.

"To justify a yield of 5 3/4% on the bond, you need to see contraction in the economy and that certainly isn't happening," Strauss said. "The numbers have given clear indications of growth and we're seeing a reaction in the bond market." He expects the 30-year bond to trade in a range of 6% to 6 1/4% until the end of the year.

The sell-off in Treasuries began last Thursday when the market received news that the manufacturing sector of the economy was gaining steam. The market was also hurt by higher gold and commodities prices, which came on the back of the German central bank's decision to cut interest rates.

The Bundesbank's ease sparked widespread rate cuts by European central banks, which pushed precious metals prices higher and fueled speculation that the U.S. economy would benefit from lower rates abroad.

The downpour of bad news did not let up this week. Yesterday, existing home sales rose to their highest rate this year. The report came in better than expected and supported the view that the housing sector is gaining steam. Recent 10-day auto sales figures have also lent credence to the notion of stronger economic growth.

Another growing concern is higher commodities prices. Prices of gold, oil, and lumber have persistently drifted higher in recent sessions and fueled fears that inflationary growth may be just around the bend. Market participants pointed toward steady increases in indexes by the Commodity Research Bureau and The Journal of Commerce as evidence that prices may be on an upward trend.

"The market rallied on declines in commodities indexes and now is getting hit by increases in them," said Tony Crescenzi, head fixed-income trader at Miller, Tabak, Hirsch & Co.

Brian S. Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson, said that in the short run, economic releases are likely to continue to display bravado and pose problems for the Treasury market. The real test of the market's health will be the gross domestic product report, Wesbury said.

Longer term, Wesbury believes that lower interest rates in Germany, France, and Japan will have a more stimulative effect on the U.S. economy than has been factored into the market. Increased buying power among consumers abroad, coupled with the weakness of the dollar, is likely to generate solid U.S. export growth.

Monday's Market

Treasury note and bond prices started yesterday's session on a firm note as buyers emerged in overseas trading and at the start of the New York session to take advantage of attractive yield levels brought on by last week's sell-off.

The 30-year bond ended down 11/32, to yield 5.99%.

Traders said the buying, which was confined to the long end, was purely speculative in nature because it was not met with significant follow-through interest.

The National Association of Realtors reported that existing home sales rose 2.6% in September to a seasonally adjusted annual rate of 3.9 million units, the highest rate this year.

Market observers said the report came in slightly better than expected and supported the view that the housing sector is gaining steam. Initially there was no reaction to the housing figures, as few players seemed willing to establish new positions or square existing ones ahead of the GDP report, slated for release Thursday.

But by late morning, the Treasury market resumed its down-trade as buying dried up and a few large sellers emerged.

A large speculative seller of 10-year notes and hedge-fund selling of the five-year managed to push prices lower across the curve, market sources said. Despite the backup in yields, no significant buyers materialized and players seemed willing to allow yields to drift higher ahead of the Treasury auctions this week.

One reason is that the two-year note has historically attracted strong demand when trading near a 4% yield. Because traders believe rates at the short end of the curve will bring buyers into the market, they are willing to allow the price of the two-year note to drift lower.

The long end of the market came under pressure throughout the day from rising commodity prices, led by higher lumber prices. Lumber futures rose as much as $8 early in the day, to a level of $378. In other figures, economists calculate that sales hit a 7.8 million units rate in the latest period.

The market stabilized through the afternoon as commodity prices edged lower and prices recouped some early losses.

On the economic data calendar today is the Conference Board's consumer confidence survey and the Johnson-Redbook survey of weekly retail sales. The most important release this week is the preliminary report on third-quarter GDP, for which economists polled by The Bond Buyer expect a reading of about 2.7%.

In futures, the September contract ended down 11/32 to 118.19.

In the cash markets, the 3 7/8% two-year note was quoted late yesterday down 1/32 at 99.29-99.30 to yield 3.90%. The 4 3/4% five-year note ended down 3/32 at 99.26-99.28 to yield 4.77%. The 5 3/4% 10-year note was down 6/32 at 102.12-102.16 to yield 5.41%. And the 6 1/4% 30-year bond was down 11/32 at 103.11-103.15 to yield 5.99%.

The three-month Treasury bill was up one basis point at 3.05%, the six-month bill was up three basis points at 3.18%, and the year bill was up two basis points at 3.31%. Treasury Market Yields Prev. Prev. Monday Week Month3-Month Bill 3.05 3.01 2.966-Month Bill 3.18 3.10 3.091-Year Bill 3.31 3.26 3.302-Year Note 3.90 3.82 3.773-Year Note 4.19 4.06 4.065-Year Note 4.77 4.63 4.677-Year Note 4.99 4.80 4.8610-Year Note 5.41 5.24 5.2730-Year Bond 5.99 5.84 5.94

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