Friday proved to be the day of reckoning for the credit markets.

The October employment statistics confirmed recent signs of strength in the economy and signaled that long-term interest rates have reached a bottom for a while.

It came as no surprise to market players that the figures reflected an economy that remains on a moderate growth path with few upward pressures on inflation, but pockets of strength contained within the figures caught the market off guard.

The Labor Department reported that nonfarm employment gained 177,000 last month, virtually right on top of market expectations. The civilian unemployment rate edged higher to 6.8% in October, from 6.7% in the previous month.

But for the first time in eight months, manufacturing employment increased, gaining 12,000, while the construction industry posted a hefty gain of 30,000 slots. Just as disturbing to the market was an advance in average hourly earnings to $10.92 from $10.87, while average weekly earnings jumped to $376.74 from 373.93, a gain of $2.81.

"The employment report implies that the bull market is over for bonds and that the economy is coming back," said Michael Strauss, chief economist at Yamaichi International Inc.

The gains in manufacturing and construction jobs were consistent with other signs of growth in the sectors, Strauss said.

The jobs figures indicate that the low interest rates - which have given various sectors of the economy a boost - are finally translating into stronger job growth, analysts said.

Investors had received a number of signs recently that the U.S. economy is gaining steam and - spooked by widespread forecasts for significantly stronger growth through the end of the year - market players were curious to see where the employment sector fits in.

The jobs release, which provided the market with its first comprehensive view of the economy's performance last month, supported the view that the economy is starting to create jobs and that growth in the fourth quarter of the year will come in around 4%, analysts said.

"It's a done deal that we're above 4% on growth this quarter," Strauss said.

But the question remains just how sustainable that growth will be. The October employment figures confirm that the economy is on a much higher growth path in the second half, but doubt remains whether the trend will continue. Therefore, a near-term change in monetary policy is unlikely.

Most on Wall Street believe that short-term economic growth will accelerate smartly in the fourth quarter and post about 4% GDP growth. The surge in economic activity will probably be due to increased consumer demand and inventory rebuilding, particularly in the auto sector. Growth at 4% is likely to create further selling pressures in the Treasury market, which could push long-term yield levels higher, analysts say.

But long term, market observers cite a number of factors that will tend to hinder any acceleration of economic growth next year. They include uncertainty over upcoming health-care reform and higher taxes, ongoing corporate restructuring, the scaling back in the defense industry, the weak commercial real estate market, and the lack of new and innovative consumer products.

As the debate over the direction of the economy wages, the market is trying to locate a comfort zone where it can tolerate stronger economic growth, said Hugh Johnson, chief investment officer at First Albany Corp.

Johnson said the market is bracing for the prospect of 4% growth or higher in coming months plus government-induced inflation as tax increases and health-care reform take effect.

On the positive side, market participants have been able to detect few signs of upward price pressures in the economy. The constructive inflation environment has lent support to Treasuries because it has kept some large retail accounts from unloading securities, Johnson said.

One potential problem that Johnson sees for the economy is the recent backup in interest rates and the prediction by many Wall Street economists that rates will rise further. Higher rates, he argued, will further temper consumer and business lending activity and keep money growth to a minimum.

Therefore, the October employment report is not expected to have a significant impact on the Federal Reserve's deliberations on monetary policy, as it provided little fresh news on the economy, analysts said.

"The Fed wants to see several months of solid strength before signaling anything to the market," said Steven Ricchiuto, chief economist at Barclays de Zoete Wedd Securities inc. "All indications show that the economy will not gain enough momentum to prompt a tightening."

Friday Market Activity

Treasury note and bond prices fell as market participants reacted to pockets of strength contained within the October employment report.

The 30-year bond ended down a half point, to yield 6.20%.

The October jobs figures provided the market with little new information and merely showed that the economy is growing, but creating jobs at a slow pace.

Players tried to take the market higher, particularly after the initial headlines indicated that the overall civilian unemployment rate rose in October. But short covering was met with selling as accounts sold on the uptick in prices and the market resumed its recent slide.

Economists generally discounted the boost in average hourly earnings as a seasonal aberration caused by several industries, as well as to improved productivity in the economy. According to Kevin Flanagan, money market economist at Dean Witter Reynolds Inc., companies are squeezing more hours out of present employees rather that hiring new ones.

Nevertheless, the market focused on the increase in average hourly earnings and in manufacturing employment, and the 30-year bond reached a yield of 6.25% for the first time in two months.

There was some scattered retail buying interest at cheaper levels and dealers hit the market with several aggressive waves of selling.

Further selling pressures emerged Friday in response to a story on the Market News Service wire that quoted a Federal Reserve source. The source was quoted as saying that if and when it becomes clear that faster growth is sustainable, probably after the new year, the Fed is prepared to tighten.

Traders said the story created significant selling pressure at the short end of the yield curve, particularly because of the upcoming supply burden as the Treasury Department kicks off its quarterly refunding auctions Tuesday.

In futures, the December contract ended down 14/32 to 115.13.

In the cash markets, the 3 7/8% two-year note was quoted late Friday down 2/32 at 99.14-99.15 to yield 4.15%, the 4 3/4% five-year note ended down 7/32 at 98.14-98.16 to yield 5.09%, the 5 3/4% 10-year note was down 13/32 at 100.02-100.06 to yield 5.72%, and the 6 1/4% 30-year bond was down 17/32 at 100.14-100.18 to yield 6.20%.

The three-month Treasury bill was down two basis points at 3.06%, the six-month bill was unchanged at 3.26%, and the year bill was up two basis points at 3.43%.

Treasury Market Yields Prev. Prev. Friday Week Month3-Month Bill 3.10 3.04 2.996-Month Bill 3.33 3.19 3.081 -Year Bin 3.54 3.34 3.192-Year Note 4.15 3.99 3.773-Year Note 4.44 4.24 4.035-Year Note 5.09 4.84 4.607-Year Note 5.31 5.01 4.8010-Year Note 5.72 5.42 5.2430-Year Bond 6.20 5.96 5.91

Source: Cantor, Fitzgerald/Telerate

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