The Wall Street Journal

September 7, 2004

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Jobs Report Yields No Surprises

Stronger Data Likely Mean
Interest Rates Will Keep
Rising at a Deliberate Pace

By MICHAEL MACKENZIE
DOW JONES NEWSWIRES
September 7, 2004; Page C4

NEW YORK -- So much for the monthly jobs shocker.

The August employment report, which nearly matched consensus forecasts, was a reality check Friday for a government bond market that had grown accustomed to monthly payrolls data well out of line with market expectations. Investors and analysts believe August's better, though unspectacular, rate of job growth, confirms that the Federal Reserve will maintain a measured pace of rate increases for 2004, including a quarter-point move at the Sept. 21 Fed policy meeting.

"If there were any doubts about a Fed-rate hike on Sept. 21, this should dispel them," said Stephen Stanley, chief economist at RBS Greenwich Capital, in Greenwich, Conn., which sees quarter-percentage-point rate increases at each of the three remaining Fed meetings in 2004.

[Chart]

Coming on the heels of weaker payrolls data in June and July, the faster pace of payrolls growth in August ends the notion of Treasurys revisiting the technically driven rally that had been lifting prices. But yields may not rise sharply, given the expectations of a moderate pace of Fed-rate increases and possibly uneven news on economic growth.

Analysts expect most of the movement in the yield of the two-year note -- the most sensitive of the actively traded Treasury benchmarks to monetary-policy expectations. "The front end is the most vulnerable part of the curve in the wake of the payroll data," noted Anton Pil, global head of fixed income at JP Morgan Private Bank in New York.

Helping to cap any aggressive rise in longer yields is the fact that the outlook for measured rate increases "sends a clear message to holders of long-dated Treasurys that the Fed will remain vigilant on inflation," added Mr. Pil.

The two-year yield, which moves inversely to its price, jumped 0.12 percentage point Friday, after the labor report.

Bond trading halted early that day, and the market was closed yesterday in the U.S. in observance of Labor Day.

At the 2 p.m. EDT early close on Friday, the benchmark 10-year note was down 19/32 point, or $5.94 per $1,000 face value, at 99 23/32. Its yield rose to 4.287% from 4.215% Thursday. The 30-year bond was down 27/32 point at 104 21/32 to yield 5.055%, up from 5.000% Thursday.

[Chart]

The August gain in payrolls is "a good number for the Fed and the president, and a bad number for traders," said Mike Franzese, head of U.S. trading at Zions First National Bank in Jersey City, N.J.

Following the jobs report, all respondents in a Dow Jones Newswires/CNBC survey of primary dealers in government securities predicted that the Sept. 21 Fed policy meeting will result in a quarter-percentage-point rise, to 1.75%, in the federal-funds-rate target. Primary dealers underwrite Treasury debt auctions and deal directly with the Fed.

However, a scenario of continuing measured rate increases would be good news for investors looking to reap the rewards of the "carry trade," in which they buy higher-yielding, longer fixed-income securities with funding linked to the lower overnight borrowing rate.

Yields of Treasurys, corporate bonds and mortgage-backed securities would remain at relatively elevated levels above a slowly rising overnight borrowing rate. That relationship provides investors with "carry." They can fund the purchases of higher-yielding assets with lower financing rates and accrue the difference over time.

Bill Chepolis, managing director at Deutsche Asset Management in New York, said mortgages, particularly those with 5.50% and 6.00% coupons, provide investors with "good carry." He expects the 10-year Treasury note to track within a narrow trading range of 4.10% to 4.35%.

In the coming week, the market may focus more on words than data, with Fed Chairman Alan Greenspan talking about the economy and other central bank officials also scheduled to speak. After the August employment report, investors expect an optimistic tone from Mr. Greenspan when he testifies tomorrow before the U.S. House budget panel on the economic outlook and fiscal issues.

Write to Michael Mackenzie at [email protected]1

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