Weak housing fuels rally on rate cut hopes

NEW YORK (Reuters) - Treasury bond prices rallied sharply on Wednesday when more weak data on U.S. housing data raised expectations for a Federal Reserve interest-rate cut.

U.S. home construction starts fell 10.2 percent in September to their lowest level in more than 14 years.

"Another really poor month in the housing sector suggested that we could see another 25-basis-point rate cut when the Fed meets next time at the end of the month," said Bill Hempel, chief economist for the Credit Union National Association.

Responding to that prospect, the benchmark 10-year note's price jumped 27/32 for a yield of 4.55 percent US10YT=RR in late trade, versus 4.66 percent late Tuesday.

The Fed's Beige Book report, an anecdotal account of business conditions across the nation, reinforced the argument for easier monetary policy. The report said economic activity grew in all of the U.S. Fed's districts, but noted the pace of expansion had decelerated since August and that housing markets had continued to weaken. ID:nWBT007731

The stock market's slide and an increase in geopolitical

risk also supported safe-haven U.S. bonds, analysts said, after the Turkish parliament approved plans to allow troops to cross into northern Iraq in search of Kurdish rebels there

Shorter-maturities outperformed longer ones, causing the difference between short- and long-term yields to widen, anticipating an October rate cut.

Short-dated instruments are most sensitive to changes in central bank policy. Two-year notes were on track for their biggest one-day rally since early September.

In afternoon trade, U.S. short-term rate futures showed a 58 percent chance the Fed would cut rates at its October 30-31, up from 38 percent overnight.

STOCKS, GEOPOLITICAL RISK

Treasuries got a second leg up when stocks, strong early in the day, turned lower around midday, analysts said.

"The pullback in stocks was a plus for Treasuries," said Stone and McCarthy Research Associates Analyst John Canavan.

The two-year note traded up 9/32 for a yield of 3.98 percent US2YT=RR, compared with 4.14 percent late Tuesday. Bond yields and prices move inversely.

The new wrinkle in geopolitical tensions also helped short-dated Treasuries.

"The Turkish parliament's authorization of an incursion into Iraq against Kurdish rebels created some preference for quality, safety and liquidity as geopolitical tensions heat up," said William Sullivan, chief economist at JVB Financial Group in Boca Raton, Fla.

"Treasuries put geopolitical risk, the stock market reversal, weak housing numbers and the Fed's Beige Book together and said, 'Hey, the Fed's got to ease' and this curve steepening is all in anticipation of a further adjustment in the fed funds target," he said.

The government also reported that its Consumer Price Index (CPI) rose 0.3 percent rate in September. Core prices -- which exclude volatile food and energy items and are of more interest to the Fed -- rose just 0.2 percent. ID:nOAT001297.

"The inflation numbers give the Fed room to cut rates," said Hempel.