Bonds edge lower as traders watch stocks

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Another record for oil prices

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NEW YORK (CNNMoney.com) -- Treasurys dipped lower after struggling for direction most of the day on Monday, as investors awaited economic data due out later this week and kept a keen eye on equities, which have taken a beating of late.

The benchmark 10-year note fell 2/32 to 99 5/32, and its yield was 3.96%, even with late Friday. The 30-year bond was down 6/32 to 97 15/32, and its yield held rose to 4.53% from 4.51%late Friday.

The price on 2-year notes fell 1/32 to 100 14/32 from late Friday, and the yield held steady at 2.63%. Bond prices and yields move in opposite directions.

With no real news to drive Treasurys, bond investors were "following the stock market," said Michael Cheah, senior portfolio manager at AIG SunAmerica. Earlier Monday, the Dow Jones industrial average, once again, dipped into bear market territory. The Dow briefly stepped into bear territory Friday before settling just shy of the technical definition of a bear market, which is 20% off the most recent high.

If the Dow continues to lose traction, it could turn out to be the third worst June for the index. And that could be good for bonds. However, Cheah said, "the stock market seems to be in a heavily oversold position and we could get some rebound." If that happens, investors would likely shift their assets back to equities. So, without any clear impetus, it's watch and wait.

"People are pretty exhausted by the end of last week and with quarter-end coming, people are getting squared up," said Steve Van Order, chief fixed income strategist of Calvert Funds.

Van Order is not surprised that Monday was a quiet day in the bond market. "There are really no headlines to really move the market one way or the other," he said.

Economic reports on tap. Investors are also waiting for two key economic reports this week. "We don't have anything to latch onto until we see the ISM number tomorrow and the employment data on Thursday," said Cheah.

The Institute for Supply Management's (ISM) manufacturing index is a key index of manufacturing. While the manufacturing sector is only a small portion of the entire economy, the report is watched closely because it is the first major reading on the economy for the month.

According to a consensus estimate Briefing.com, economists are looking for a reading of 48.6, which would register as a decrease from last month and a contraction of the sector.

The June unemployment rate is due out on Thursday morning from the U.S. Department of Labor. Economists surveyed by Briefing.com are looking for 5.4%, which is slightly less than the 5.5% unemployment rate in May.

The unemployment rate is one of the most highly anticipated readings on the health of the economy each month.

Inflation concerns and a weakening economy. The current economic climate - where investors are worried about both an economic slowdown and higher prices - has bond traders worried about an effect called a "bear steepener," says Van Order.

In a "bear steepener," yields on the bonds with longer term maturities are pushed higher, as investors worry about inflation long term. The bond market has not seen a "bear steepener" in a long while, said Van Order.

"We are worrying about that outcome, but we are not acting on that outcome," said Van Order, because the bond market still has faith in the Fed, he says, to raise interest rates if inflation looks like it is getting out of control. "There is some confidence in the Fed, but we will see what happens," said Van Order.

Oil and gas. In other markets, both retail gas and oil records rose to record highs on Monday. The national average price for a gallon of gasoline climbed to $4.086, according to a daily survey by motorist group AAA. Crude prices hit $143.67 a barrel, setting a new trading record more than 50% above prices at the end of 2007, before settling down lower at $140 a barrel for the day.

"On the one hand, there is the lingering fear that higher oil prices would be inflationary, which is bad for bonds," said Cheah. "On the other hand, when the consumer pays more for gas, the consumer has less money left for discretionary spending which would weaken the economy, which would be good for the bond market," he added.

Van Order made the same comments about the mixed effect of oil prices on the bond market. Higher energy prices raise inflation worries, which is bad for the bond market. "The other way you have to look at the impact of rising oil and food prices is that it is dampening consumption," he said.