The Wall Street Journal

November 10, 2004

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See commentary2 covering releases, events and flows affecting the Treasury market, from


Here are the results of yesterday's Treasury auctions. All bids are awarded at a single price at the market-clearing yield. Rates are determined by the difference between that price and the face value.


Four-Week Bills

Applications $60,763,106,000
Accepted bids $24,000,216,000
Accepted noncompetitively $73,995,000
Accepted frgn noncomp $0
Auction price (Rate) 99.857500 (1.900%)
Coupon equivalent 1.929%
Bids at market-clearing yld accepted 56.81%
Cusip number 912795RQ6
The bills are dated Nov. 12 and mature Dec. 9.


Five-Year Notes

Applications $43,473,142,000
Accepted bids $15,000,233,000
Bids at market-clearing yield accepted 44.54%%
Accepted noncompetitively $211,142,000
" foreign noncompetitively $105,000,000
Auction price (Rate) 99.954506 (3.510%)
Interest rate 3½%
Cusip number 912828DB3
The notes are dated Nov. 15 and mature Nov. 15, 2009.


Strength of TIPS vs. Treasurys
Is Likely to Get Fed's Attention

Surge in Performance Shows
Concern of Some Investors
That Inflation Will Rise

November 10, 2004; Page C4

NEW YORK -- When Federal Reserve policy makers meet today, a good deal of attention likely will focus on recent investment flows within the bond market.

One glaring feature has been a much stronger performance by Treasury Inflation-Protected Securities, or TIPS, relative to conventional Treasurys. The break-even inflation rate, or difference between conventional Treasury yields and those of TIPS, has swelled to as much as about 2.54% in the 10-year sector, from 2.38% in early October.

The widening occurred even though the 10-year benchmark bond yield hasn't changed much in the same period. The wider break-even reflects concern among some investors, notably longer-term money managers, that inflation will rise and that the central bank has fallen behind the curve and needs to raise its rate target a lot faster than what interest-rate futures are predicting.

Because Fed officials have said break-even levels are a good proxy for inflation expectations, there is little doubt that they will be keen to ascertain why TIPS have been on fire of late, and what it means for monetary policy. "The Fed spends a great deal of time analyzing what happens in the TIPS market," said Anthony Chan, senior economist at J.P. Morgan Fleming Asset Management in New York and a former economist at the Federal Reserve Bank of New York.

[Treasury Yield Curve]

What makes the situation interesting for the Fed is the recent performance of cash Treasurys. The difference between two- and 10-year yields has been narrowing, a sign that the bond market isn't overly worried about higher inflation. Indeed, Friday's news that 337,000 jobs were created in October, rather than an expected 192,000, has helped narrow the difference more, because the stronger jobs picture fueled expectations of more aggressive Fed tightening.

Not only do investors expect the 1.75% federal-funds rate target to reach 2% today, the odds of a further rise to 2.25% at the Fed's December meeting have risen to around 75%, from 50%, followed by more rate increases early next year, based on market levels.

A narrowing in the two- to 10-year yield gap and further Fed tightening should lead to "tighter break-evens" in TIPS, said Eric Hiller, chief global derivative strategist at Bank of America in Chicago.

Yet, demand for TIPS suggests a substantial group of investors aren't so sanguine about the Fed's ability to control inflation. Despite a recent pullback in oil prices, the October surge in energy prices resulted in "substantial inflows from money managers into TIPS because of higher inflation expectations," said John Roberts, managing director of fixed income at Barclays Capital in New York.

The conventional bond market has tended to focus more on the growth-damping effects of high energy prices, rather than the potential effect on inflation. But long-term bond investors appear to be fretting more about the latter. Last month, Bill Gross, managing director at Pimco, reiterated his belief that owning TIPS makes sense. That in turn sparked a further rally in TIPS.

[10-Year Treasury Note Yield]

Demand for TIPS surprised traders, serving to amplify the rally, said Mr. Roberts. The scale of demand was also too much for what remains a small outstanding market, he added.

The TIPS market comprises 15 separate issues with a total value of $277 billion. That is a sliver, compared to the overall Treasurys market's size of around $3.6 trillion as of June 30, according to the Bond Market Association.

The 10-year break-even inflation rate is still below its recent peak of around 2.76% in May, when inflation fears last were high. "Break-evens are in the middle of their range, and only if they rise further will the Fed start to worry," Mr. Roberts said.

In trading yesterday, Treasurys ended slightly lower as a sharp drop in oil prices offset good demand in the Treasury's auction of $15 billion of new five-year notes. At 4 p.m., the benchmark 10-year note was down 1/32 point, or 31 cents per $1,000 face value, at 100 7/32. Its yield rose to 4.222% from 4.218% Monday, as yields move inversely to prices. The 30-year bond was down 5/32 point at 106 10/32 to yield 4.943%, up from 4.932% Monday.

Corporate Bonds

Moody's Investors Service cut long-term ratings of Merck & Co. two notches to double-A2. The ratings firm cited, among factors, loss of revenue and cash flow associated with Merck's withdrawal of its Vioxx drug, "increasing concerns regarding Merck's Vioxx litigation exposure" and erosion of Merck's competitive position. Moody's said Merck's ratings remain under review for possible further downgrade "as the Vioxx situation continues to develop, and as Moody's further assesses how the above issues may affect Merck's credit profile, operating and financial strategies."

Merck didn't comment on Moody's action. In trading, Merck's 5.95% bonds due 2028 were quoted 0.06 percentage point wider at 0.91 percentage point above Treasurys, according to MarketAxess's BondTicker.

--Aparajita Saha-Bubna and David Feldheim contributed to this article.

Write to Michael Mackenzie at michael.mackenzie@dowjones.com1

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