Bond Market Rally

The bond market has mounted an impressive rally since late March. The
Lehman Twenty Year iShares (TLT) has moved 10% higher over this time
period, putting the index back at 2003 levels when everyone was taling
about 'deflation'.

The rally in long dated bonds has been sizable. Yields on the 30-year
treasury are down -23 basis points alone over the past month, putting
them at 4.34%. Similarly, rates on thirty-year fixed mortgages are down
to 5.27% from the high 5% to low 6% level they've bounced around over
the past year. Likewise, the yield on the ten-year treasury has fallen -22
basis points to 4.02%.

Meanwhile, the yield on the short end of the curve has continued to
modestly rise, with 3-month yields at 2.80% and 6-month yields at 3.03%.
This environment of rising short rates and falling long rates has worked to
flatten the yield curve. For example, only 102 basis points of sunlight now
exist between the 3% Fed Funds rate and the 4.02% Ten-Year note.
This compares to a spread of over 380 basis points only one year ago!

The Fed has steadily increased the Fed Funds rate over the past year and
indicated that it will continue to do so. This has increased short rates from
artificially low levels that were meant to be extremely accommodative in
order to ward off deflation and post 9/11 trauma felt in all sectors of
economy. While rates have increased on the short end, the long end of the
curve has seen rates decline as investors have grown more convinced that
the Fed is serious about tackling inflation.