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Bumpy ride for Treasuries in first quarter

bonds, treasuries, qe2, inflationTreasury yields rallied at the end of 2010 on signs of an economic recovery, but 2011 has been a tug of war between an economic recovery and geopolitical crises. By Catherine Clifford, staff reporter

NEW YORK (CNNMoney) -- The Treasury market bounced around a bunch in the first three months of the year, but it didn't really go anywhere, as investors were pulled between signs of a recovering economy and a slew of geopolitical crises.

The yield on the 10-year Treasury started the quarter at 3.36% and ended the quarter at 3.47%. Yields dipped slightly Friday. But it wasn't a smooth ride.

In the middle of March, upheaval in the Middle East and the earthquake in Japan led to increased demand for the safe haven of Uncle Sam's debt. That pushed yields as low as 3.14% at one point.

But those "flight-to-quality bids" may have been temporary, said William Larkin, portfolio manager at Cabot Money Management. He said progress in the Middle East and a resolution of Japan's nuclear crisis could push interest rates higher.

The 30-year bond yield trajectory is a good indicator of the long-term, according to Larkin. And in the past 6 months, the rate on the 30-year long bond has been climbing steadily higher. The 30-year yield was at 4.49% Friday.

Long term bond yields have been rising on signs that the U.S. economy is improving. A report from the government released Friday showed the economy gained 216,000 jobs in the March, an improvement over the previous month.

"Maybe we will have a strong monthly April report and May report and then suddenly we go into June and it will be obvious we are out of this," said Larkin. "I am thinking that by the time we get to June it is going to be obvious to everyone that things are much better."

Mary Ann Hurley, vice president of fixed income at D.A. Davidson, disagreed. She thinks the economy may stall. "I think it will be very, very choppy," she said. "At the end of the second quarter or at the beginning of the third quarter, I think rates will be lower."

Higher oil prices will cut into consumer's disposable income, the housing market "could be heading into second downturn," and the labor market has a long way to go to recover from the hemorrhaging of jobs that the economy suffered during the Great Recession, she said.

The bond market is looking to June: The government's $600 billion bond-buying program, announced in early November, comes to a close at the end of June. The Federal Reserve has been systematically stepping into the Treasury market and buying debt, flooding the market with liquidity in an effort to spur the economic recovery.

"That is a big buyer. Anytime you have a buyer in the marketplace like that, that is going to have an impact," said Larkin. But just how big remains to be seen.

If the economy is solidly in a recovery, the bond market might stabilize without the help of the Fed. But a gradual winding down of quantitative easing, more commonly referred to as QE2, would be better than an abrupt stop, said Larkin.

Moreover, Hurley said the quantitative easing program hasn't had the desired impact. While the program added fuel to the stock market rally of the past few months, the dollars are not doing what they should be doing to spur a recovery.

"In order for the economy to grow you need money to be [lent out] and it is not," said Hurley. After all, interest rates have been on the rise since the program was announced last year.

"The concern is that the bloated balance sheet is going to be inflationary in the longer term," said Hurley. And now that concerns about the government's record deficit have taken center stage in Washington, it isn't likely that there will be much more stimulus spending, she noted.

Once QE2 ends, the bond market will probably be more concerned with when the Federal Reserve will raise its key lending rate.

"We are not in the same hole that we were before and it doesn't make sense to keep overnight lending rates at zero," said Larkin, noting that while the Fed won't likely move rates this quarter, "it is priced in for the end of the year." To top of page

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