There was enough weakness in yesterday’s report on existing home sales for December to keep pessimism alive about the economic outlook for 2007. But the bond market wasn’t waiting around for definitive signs and instead ran for cover. (Update: Since we posted this morning, new home sales numbers for December were released, reporting a gain of 4.8%. As a result, new home sales rose last month to their highest since April, offering an optimistic offset to yesterday’s less-inspiring news on existing home sales.)
The selling yesterday pushed the yield on the 10-year Treasury up sharply, closing at around 4.87%, the highest since last August. The notion that the economy will stay fairly robust has apparently taken root in the hearts and minds of bond traders and planted the fear that rates may rise before they fall. For the fixed-income set, that’s reason enough to become defensive.
But while the trading floors focused on the 10-year Note seem to have blinked in deference to the growth-will-be-stronger-than-expected crowd, there are no signs of capitulation (yet) over in Fed funds futures pits. Looking at the array of contracts expiring in coming months, one theme is clear: the popular bet at the moment is a Fed that will hold rates steady at 5.25% for the foreseeable future. That’s been the bet for some time now, based on recent history in Fed funds trading, and it appears to be the consensus view for pricing Fed funds through the summer.