Wed Jul 21, 2004
By Ellen Freilich

NEW YORK, July 21 (Reuters) - U.S. Treasury debt prices buckled on Wednesday, pressured by a rally in equities and expectations official interest rates were likely to almost double before the year was out.

Tuesday's unambiguously upbeat testimony on the U.S. economy by Federal Reserve Chairman Alan Greenspan's seemed to portend a rate hike at each and every policy meeting remaining this year, analysts said.

And that impression got fresh reinforcement on Wednesday from Philadelphia Fed President Anthony Santomero who asserted that U.S. interest rates have some distance to rise before reaching neutral -- a level that neither stimulates nor depresses the economy.

Santomero, echoing Greenspan's view, said the neutral rate would vary over time depending on the state of the economy.

Greenspan makes a second appearance on Wednesday, this time before the House Financial Services Committee of Congress.

Equites (NDU4: Quote, Profile, Research) were competing for investor cash after Microsoft (MSFT.O: Quote, Profile, Research) said it would return $75 billion in cash to shareholders and Ericsson (ERICb.ST: Quote, Profile, Research) released pleasing results.

The benchmark 10-year note (US10YT=RR: Quote, Profile, Research) lost 8/32 in price, lifting its yield to 4.49 percent from 4.45 percent late Tuesday and 4.36 percent before Greenspan's first appearance.

"The comments from Greenspan in the Q&A session that July data shows a snap back in auto sales and spending in general and also in jobs should be taken to mean that he has anecdotal evidence of a rebound," noted Richard Gilhooly, fixed-income market strategist at BNP Paribas.

"We consider the near term risks to be for a further back-up in rates, especially if two-year yields can break above the 2.64 percent level," he added.

The two-year note (US2YT=RR: Quote, Profile, Research) was doing just that as its yield rose to 2.69 percent from 2.62 percent on Tuesday.

The five-year note (US5YT=RR: Quote, Profile, Research) eased 6/32 in price, taking its yield to 3.72 percent from 3.67 percent. At the long end of the curve, 30-year bonds (US30YT=RR: Quote, Profile, Research) shed 14/32, leaving yields at 5.21 percent from 5.17 percent.

The spread between two- and 10-year yields narrowed to 181 basis points, its lowest level since October 2002.

Analysts were generally agreed that Greenspan had been more hawkish than the market expected.

"He implied that the Fed would go at a "measured" pace or faster. He stressed the importance of the incoming data on costs and prices. He was generally dismissive of the slowdown in consumer spending and didn't show any anxiety about the softness in the June data set," cited Bill Dudley, chief economist at Goldman Sachs.

Some bond bulls had been hoping recent signs of a slowdown would temper the Fed's tightening plans, perhaps allowing it to skip a hike at one of the four remaining meetings this year.

"The testimony reinforces our view that the FOMC is on track for 25 basis points per meeting for at least the next few meetings," said Dudley, who is looking for rates to end this year at 2.25 percent, and at 3.5 percent next year.

Still to come on Wednesday are speeches from Fed Vice Chairman Roger Ferguson and Fed Bank of Dallas President Robert McTeer.

Chairman Greenspan begins his second testimony before the House Financial Services Committee at 10 a.m. (1400 GMT).

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