Long-term Treasury prices hovered near record highs all last week as the market got a series of weaker-than-expected economic indicators, capped by the report of a measly 13,000 increase in June nonfarm jobs.
On Friday, the long bond closed for the third time in five days at 6.66%, the lowest closing yield recorded since the Treasury began issuing 30-year bonds regularly in 1977.
Traders said Friday's gains were limited because the bond market had already priced in the employment news. The long end of the market also came under pressure late last week as soaring commodity prices reawakened the market's inflationary fears.
The 13,000 increase in June jobs marked a sharp deterioration from the healthy gains of 215,000 in May and 255.000 in April.
The June gain was also much weaker than the consensus forecast for a 130,000 increase. But the report was not far from some low forecasts that bond traders had focused on, including Goldman, Sachs & Co.'s prediction of a 25,000 gain.
The 53,000 drop in June manufacturing jobs echoed other reports showing the manufacturing sector is lagging, including last week's June Purchasing Managers' Index. The weakness in goods-producing employment was offset by a 79,000 rise in services jobs.
The June statistics also showed declines in hours worked, factory overtime, and average hourly wages, and a 0.1-point increase in the unemployment rate, to 7%.
Economists said the report showed that growth has slowed again, but not so much that the economy is in danger of falling back into recession.
"Once again the economy's spinning its wheels, and this time the source of weakness is the inventory correction that got under way in late winter or early spring and was running full blast in June," said Robert Dederick, chief economist at Northern Trust Co.
Dederick said the weakness in the June report was somewhat exaggerated. Seasonal factors may have depressed the June statistics, and the soft numbers may also be in part an offset to May's strong report, he said.
"But even when you incorporate all of those [factors] in your thinking, you still have an economy that's struggling." Dederick said.
Michael Moran, chief economist at Daiwa Securities America, agreed that the June report had overstated the softness in the employment market and said he expects jobs growth to bounce back in July.
Analysts said the meager June jobs growth definitely bars any near-term tightening from the Federal Reserve, and may even prompt Fed officials to shift back to a neutral policy directive from their current bias toward tightening at this week's meeting. A two-day Federal Open Market Committee meeting begins today.
"I would say it's not that important of an issue, but there's a chance they could back away from a biased directive and go to a symmetrical directive," Moran said.
William Dudley, a senior economist at Goldman Sachs, said he thought Federal Reserve Chairman Alan Greenspan would prefer to have a neutral directive in place when he testifies on monetary policy on Capitol Hill in this month's Humphrey-Hawkins hearings.
"It would seem odd to have a directive in place that implies the Fed is more likely to tighten than ease in a quarter where growth is likely to run 1.5% to 2%," Dudley said.
In spite of Friday's tepid employment report, some economists said the long end's rally may be coming to an end. They think the lackluster indicators the market has seen recently will be succeeded by stronger numbers in the third quarter.
Dederick said the economy should begin to improve during the third quarter as the inventory correction runs its course, the construction sector picks up, and auto manufacturers increase production.
That prospect means interest rates are probably touching bottom right now, he said. "In the third quarter, as the economy begins to show signs of strength, they'll begin to move higher," Dederick said.
But Dudley argued that the 30-year bond yield can get down as far as 6 1/4% over the next three to six months.
"We think two things will happen," Dudley said. "The inflation news will be better, so the inflation fears will fade, and we will get Clinton's deficit reduction package through, which will make fiscal policy restrictive, which will allow the Fed to keep monetary policy accommodative.
"If the Fed keeps monetary policy accommodative, that implies long-term rates should fall," he added.
Treasury traders said Friday that an uptick in gold and other commodity prices was creating a problem for the long end of the market.
"If it wasn't for gold, if it wasn't for the [Commodity Research Bureau Index], we'd be doing a lot better," a government bond trader said.
The Commodity Research Bureau Index rose more than 3% last week to close at 212.01, and gold got above $390 an ounce as it resumed its rally.
But Dudley said the market was misinterpreting the rise in gold prices as a sign of future inflationary problems. "I don't think it has anything to do with the U.S. or with global inflation," he said.
Dudley said the bond market had ignored the good inflation news contained in the June employment statistics.
"Average hourly earnings in this report were off a penny and only rising at a 2.3% annual rate over the last year," Dudley said. "It's hard to imagine any significant acceleration in inflation if you don't have any wage pressures."
On Friday, prices rallied immediately after the jobs number, wilted almost as quickly, then made their way back to the session highs by the end of the shortened trading session.
The 30-year bond closed 1/4 point higher to yield 6.66%.
The initial rally was met with selling, which forced the market off its highs. The long end moved into negative territory during the morning when commodity prices rose.
But the market ended on a positive note after heading higher as the close of the futures market approached. Traders said the gains might have been caused by short-covering and noted that flows were very thin by that time.
A coupon trader was pessimistic about the near-term outlook. He suspects the market's technical situation has taken a turn for the worse, even though there are no coupon auctions until the end of this month.
The trader said the bullish sentiment that developed in recent weeks, combined with the end of the fiscal quarter last Wednesday, forced many investors into the market to buy. "Now there are no more buyers," he said.
Meanwhile, the flow of cash from other fixed-income markets has also subsided. Buying for municipal defeasance deals has diminished and mortgage-backed portfolio managers seem less worried about prepayment risk than they were only a few days ago, the trader said.
The September bond futures contract closed 9/32 higher at 114 5/32.
In the cash market, the 7 1/8% 30-year bond was 9/32 higher, at 105 29/32-105 31/32, to yield 6.66%.
The 6 1/4% 10-year note rose 1/4 to 103 21/32-103 23/32, to yield 5.74%.
The three-year 4 1/4% note was up 7/32, at 100-100 2/32, to yield 4.22%.
Rates on Treasury bills were lower, with the three-month bill down four basis points at 2.95%, the six-month bill off five basis points at 3.06%, and the year bill seven basis points lower at 3.21%.
Treasury Market Yields Prev. Prov. Thursday Week Month3-Month Bill 2.99 3.13 3.166-Month Bill 3.13 3.26 3.371-Year Bill 3.31 3.48 3.652-Year Note 3.91 4.07 4.303-Year Note 4.22 4.37 4.645-Year Note 4.96 5.10 5.347-Year Note 5.37 5.45 5.7110-Year Note 5.74 5.80 6.0830-Year Bond 6.66 6.70 6.90
Source: Cantor, Fitzgerald/Telerate