Wednesday, September 12, 2007

Interest Rates About to Drop?

Well, that's what the bond traders think. From September 12, 2007

U.S. 10-year Treasury bond prices continued to slide today, as traders ease off buying bonds on expectations of a guaranteed rate cut. Traders have priced in a 100% chance of a Fed rate cut next week, which is allowing bonds to take a breather after nearly 2 months of straight rallying. Bonds typically rise on economic weakness and fall on economic strength, so traders have taken a mostly defensive stance ahead of next week's Fed announcement.
The dollar fell to new lows versus the euro, and was down against the yen, as traders bet that the U.S. Fed will cut rates next week to ease economic pressures. The recent credit crisis shook up the currency markets, with the yen rallying on equity weakness, as traders exited the carry trade. The dollar has been under major pressure in the last weeks ahead of the Fed meeting; with an almost guaranteed rate cut on the way, many traders are taking positions against the dollar on overall slowing growth and credit exposure.

I'm a bit confused why bond traders would "ease off buying bonds" if they expect an interest rate cut. Normally a cut in interest rates causes existing bonds to rise in value, because newly issued bonds will likely be at a lower interest rate than existing bonds. I would expect that if anything, stopping the buying of bonds would be an indication that someone is expecting interest rates to rise.

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