Bonds Rally Early Before Settling Back to Post Modest Gains

The market is now awaiting tomorrow's jobs data.
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A bit of fear-related buying in a very thin market has got the Treasury market higher, even if both this morning's

initial jobless claims

and

productivity

data knocked the market back. A sudden widening in swap spreads, an indicator of how comfortable the market is with risk, jolted traders into buying Treasury securities, especially in the short- and long-term sectors.

Lately the 30-year Treasury bond was up 16/32 to trade at 88 21/32, dropping the bond's yield by 2 basis points to 6.08%. The two-year note was up 5/32, yielding 5.53%.

Initial jobless claims rose by 4,000 to 279,000 for the week ending July 31, the second-lowest reading this year. Meanwhile, productivity only rose 1.3% in the second quarter, and the

Reuters

consensus was for a 1.8% increase. Unit labor costs showed their biggest one-quarter gain since the fourth quarter of 1997, rising 3.8%.

The long end of the Treasury market held onto most of its rally after the 10 a.m. EDT productivity release, prompting one bewildered futures dealer to say: "Both those

reports are real numbers -- we know those are true, and they suck for the market."

The 30-year bond at 9:29 a.m. EDT rose 17/32 to 88 29/32, while the two-year note was up 8/32 to 100 at 9:40 a.m. Two sources attributed selling by a Japanese institution to the widening in 10-year swap spreads from 105 yesterday to 115 this morning. A swap spread refers to the rate a buyer will pay to exchange interest payments on a fixed-rate instrument such as a Treasury bond to that of a floating-rate instrument (such as three-month LIBOR). (Last year, when

Long Term Capital Management

blew up, swap spreads widened at about 97 basis points.)

"It caused a bit of a flight to quality in the front end," said Ken Fan, Treasury market strategist at

Paribas Capital Markets

, who added that the 10-year note, lately up 11/32, is being held back by corporate supply.

Since spreads for highly rated corporate bonds frequently track swap spreads, this is an indication of how comfortable the market is with risk. "To some degree, the width of those spreads indicates what people think about the quality of those credits relative to Treasuries," the trader added. The more risk averse the market is, its more likely to run to safer Treasuries. Lingering fear of Y2K is partly responsible for the widening in risk spreads from 70 basis points three months ago.

The headline second-quarter productivity and unit labor costs figures knocked the market down. However, the year-over-year trend is still healthy for the market, part of the reason why bonds were able to hold some this morning's gains. Unit labor costs rose at a 3.8% rate for the second quarter, but on a year-over-year basis costs are up just 1.4%, compared with 2.3% at this time last year. Meanwhile, productivity rose just 1.3%, but on a year-over-year rate, productivity is up 2.9%, compared with 2% at this time last year.

Heading into tomorrow's July

employment report

, the most-watched monthly release, today's claims report is like getting hit on the head with a broken record. Think the labor market's tight? Excepting the previous week's report, when claims totaled 275,000, today's release is the lowest one-week figure since July 26, 1997. The four-week moving average for jobless claims fell to 295,000, lowest since mid-March.