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Don't Count Bonds Out


Back in early 2001, when Wall Street was still forecasting solid growth for what eventually proved to be a recession year, one independent research firm took a contrarian view.

The Economic Cycle Research Institute, which tracks a number of leading indicators, said recession was imminent, and it turned out they were right on the money.

Recently, ECRI has resisted predicting a contraction despite all the gloom surrounding the housing market. But that could be about to change, a shift that might herald further gains in government bonds despite Thursday's dramatic selloff.

The growth rate on the firm's weekly leading index fell to minus 7.1 percent last week, a six-year-low that Managing Director Lakshman Achuthan says points to an increasingly inevitable period of economic contraction.

"We're running out of time if we want to avert a recession," he said. "The self-reinforcing downturn has just begun."

This means Treasuries, which many deem overvalued, might still stand to benefit from further downturns in the data, as well as bad news from the banking sector.

Bond yields have fallen to their lowest in over four years as the troubles that began in housing spread to the rest of the financial system. A recent stock market slide has accentuated the Treasury market's gains.

In the absence of major data releases on Friday, analysts said bonds could bounce back after across-the-board losses on Thursday, including a vertiginous drop of over 3 full points in the price of the 30-year bond .

The Federal Reserve has already slashed interest rates by more than two percentage points since September, yet many argue this has done little to assuage the anxiety plaguing financial markets.

Wall Street expects more rate cuts in March, a prospect that will further bolster bonds -- even if yields remain well below fed funds.

"The Fed's actions have so far failed to soothe investors," said Thomas Higgins, chief U.S. economist at Payden & Rygel. "Event risk remains high with fears of downgrades of bond insurers increasing the prospects of further write-downs in the financial sector. Financial markets remain volatile and there has been a flight to safety in the U.S. Treasury market."
VIEW THIS ARTICLE ON REUTERS