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Bonds, dollar take unusual tandem dip


NEW YORK -- For every rule, there's an exception, or so conventional wisdom says.

For much of this year, U.S. government bonds and the dollar have moved in opposite directions. News of a dismal economy usually has driven the dollar down, but it has helped bonds by diminishing the risk of inflation.

Yesterday proved to be a dramatic exception to that rule. The dollar plunged to an all-time low of 1.4253 German marks despite concerted central bank intervention designed to stem the currency's slide. The dollar has suffered for weeks from the wide gap between low U.S. interest rates and high German rates.

The dollar's misfortunes yesterday quickly spilled over into the bond markets, where traders sold Treasuries on the hunch that the Federal Reserve was unlikely to cut interest rates any time soon.

The benchmark 30-year Treasury closed down 1/2 point to yield 7.35 percent.

As the dollar continues to set all-time lows in the next few weeks, it and the Treasury market might move together rather than diverge.

That's especially true now, because with every new dip in the dollar, the chances of a rate cut by the Federal Reserve become more distant, analysts say.

A rate cut, even now, is "out of the cards," said Joseph Plauche, an analyst at Dean Witter Reynolds. "There's no way, with this dollar weakness, they can cut rates. They need the country going back into a recession to ease [credit] again."

"If the Fed cuts rates now, the dollar's going to go through the floor," said Joel Kazis, managing director and head of government bond trading at UBS Securities.

AThe floorboards gave way yesterday, and the dollar looks as if it might soon crash through the next story.

"Basically, the central banks really have set the market up to push the dollar even lower," said Doug Bate, senior trader at Barclays Bank in London. "As soon as they pulled out it went down again. We'll see 1.4200 tested next week."

But that's not the end of the dollar's misery, analysts said.

"My likely target is 1.40 or 1.41 marks, but there's definitely a risk of the dollar going as low as 1.35 or 1.37," said Steven Poser, a technical analyst at Deutsche Bank Capital Corp.

Dean Witter's Mr. Plauche said the bond could drop an additional 5/8 early next week, to yield more than 7.40 percent, as the dollar continues its descent.

How long bonds and the dollar will move in tandem depends on how well the U.S. economy performs in the next few weeks, analysts say.

"Anyone betting on an ease any time soon probably revised that bet" Friday, said William Sterling, an economist at Merrill Lynch. "But if the next two employment reports are weak, the Fed will ease no matter where the dollar is."

If, on the other hand, the U.S. economy begins to show signs of life in the autumn, that could turn the dollar around. An economic recovery could lift the dollar to 1.50 marks or even a little higher by the end of the year.

"If we're right about the U.S. economy, and it starts to improve, there's a possibility the dollar will not only recapture recent levels, but even go a little higher," said John Lipsky, chief economist at Salomon Brothers.

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