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Bond Brief: Fed Debate Resumes

The long end slips as jobs data revive concern about the outlook for future rate hikes.

Updated from 11:13 a.m. EST

Bond prices closed lower Friday after a mixed monthly employment report left the market unable to judge whether the

Federal Reserve

will raise interest rates at its next two meetings.

The benchmark 10-year note ended the day down 7/32 to yield 4.38%, up from 4.35% late Thursday. The 30-year bond lost 7/32 to yield 4.56%, up from 4.54%.

The short end hovered closer to break-even, and the spread between the 10- and two-year yields ended the day at just 2 basis points. The two-year lost 2/32 of a point to yield 4.36%, while the five-year fell 5/32 of a point to yield 4.32%.

The December payrolls figure rose by just 108,000 in December vs. expectations for a rise to 200,000. But the November figure was upwardly revised to 305,000 from the originally reported 215,000 to reflect a far stronger post-hurricane rebound.

The unemployment rate returned to 4.9%, down from 5% in the previous month. Hourly earnings rose 0.3%, a 3.1% increase from a year ago.

"The change in nonfarm payrolls was lower than expected, but the underlying number was strong," said Steve Bohlin, portfolio manager at Thornburg Investment Management, noting the drop in the unemployment rate and increase in hourly earnings.

The stronger November figure prevented a bond sell off, as it soothed some inflation hawks with the promise of more rate hikes in January or even March.

"The market is up in the air over March, and I'm with the market on this one because there's really no way to tell right now," said David Ader, a bond strategist at RBS Greenwich Capital.

The fed funds futures rate has priced in an 86% chance that the central bank will raise the overnight lending rate to 4.5% at this month's Federal Open Market Committee meeting, but only a 44% chance that it will raise to 4.75% in March.

"We have 80 days, or two full months of data to contend with, until the March meeting," Ader said. "The Fed will be fully neutral by the end of January. We're getting a new Fed chief. We really have an absolutely clean slate."

Dallas Fed President Richard Fisher, who was a voting member of the FOMC in 2005, and Boston's Cathy Minehan spoke about policy uncertainty, but their remarks gave the market little it did not already know.

Minehan would only say that interest rates are "near the bottom of what is considered a neutral range," but gave no hint as to when the rate hikes would end.

"It's a data-dependent market, and we're too close to neutral to judge policy two or three months out," Ader said.

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Bohlin agreed that trade will be data dependent in the next few weeks.

"We have GDP growth that has shrugged off the hurricanes, and if the true core economy is doing well, then there could be a 75% chance that rates go up in March," he said, adding that the direction of the Treasury market also will be heavily dependent on whether foreign entities continue to buy U.S. debt.

He said that foreign buying has held long rates down, despite 13 rate hikes on the short end, a phenomenon that fueled the housing market, as well as many other sectors.

On the other hand, foreign purchases of U.S. securities also has subsidized U.S. imports and stifled the growth of jobs offering good pay and benefits, according to Peter Morici, a professor with the University of Maryland's Robert H. Smith School of Business.

"Foreign banks have to do something with all the dollars they're receiving ... and the question is, since the rest of the world is growing quite nicely right now, will they diversify away from dollars?" Bohlin said. "We might see some slowing in Treasury purchases."

Ader said that the employment report wasn't the only reason Treasuries ended the session lower.

"We're looking forward to an awful lot of corporate issues coming out, and we'll see hedge-related Treasury selling," he said. "Companies will lock in."

When a company announces it will issue bonds, it will often hedge its bets by selling off assets, including Treasuries, said Steve Rodosky, senior vice president with Pacific Investment Management Co.

If demand for its corporate issue seems strong, the company will often buy back Treasuries when the day of issuance comes, giving government bonds a lift, Rodosky added.


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R.H. Donnelley



NRG Energy

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all announced Friday that they will issue debt.