Bond Brief: Minor Bounce

In her speech to a bankers' group in Naples, Fla., she struck a more dovish tone than St. Louis Fed President William Poole, who said late Friday that a 5.25% fed funds rate "sounded reasonable."

The fed funds futures contract shows that traders are certain that the central bank will take the overnight lending rate to 5% at its May 10 meeting. Fed funds futures show 54% odds that the rate will go to 5.25% at the next meeting on June 29, up from about 30% last week.

Treasury prices, which move in opposition to their yields, sank to new depths Friday after the March payrolls report and the ISM non-manufacturing index showed signs of robust employment activity. Soaring commodities prices also added to the bearish attitude, since precious metals are often seen as a hedge against inflation. And higher oil prices fueled fears, since economists have been waiting for more than a year to see if high fuel prices would finally lift core inflation numbers.

Bond traders loathe inflation because it erodes the value of fixed-income assets.

Fed policy makers are debating whether the jobless rate has fallen so far that it could spark wage inflation. The Federal Open Market Committee has raised the benchmark fed funds rate 15 straight times since 2004, to 4.75% last week. The central bank hopes to bring borrowing costs to a level that lets the economy grow without stoking inflation.

In an interview Friday with Bloomberg, Poole also said that while he's unsure about how high rates should go, he wouldn't tighten based on strong job growth alone.

"There are pockets of tightness in both the physical capacity and the labor market, but there are a lot of other places where there's a lot of excess capacity," Poole said.

Economists within the central bank disagree on when strong employment gains will finally ramp up economic activity and spark wage inflation.

Poole believes that the relationship between inflation and the unemployment rate is very weak. In a recent speech, he said: "There's room for employment to grow and scope on the upside without there being inflation consequences."