Bonds Reverse Yesterday's Course, and Await Payrolls

A rout in European bond markets and June NAPM data pressured the Treasury market.
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The bond market took it on the chin today, giving back about two-thirds of yesterday's gains. The

Federal Reserve

gave the market impetus to rally yesterday when it shifted back into neutral after raising interest rates by a quarter point, but that doesn't change the fact that economic data still show the economy's running like mad.

Treasuries came into the morning under water by almost a point, as a rout in European bond markets caused overseas portfolio managers to tar and feather the Treasury market. From there, things worsened -- the

National Association of Purchasing Management's

manufacturing survey increased to its highest level in almost two years, and bonds were suddenly off 1 18/32 just after 10 a.m. EDT. Lately the 30-year Treasury bond was down 14/32 to 89 18/32. The yield rose 4 basis points to 6.01%.

The NAPM "reaffirmed the fact that the economy is still just rolling along," said Roseanne Briggen, market strategist at

MCM Moneywatch

. "If you read the

Fed minutes

released today from the May meeting, their concern was employment being so tight. The Fed's statement after its announcement was somewhat soft, but they still could tighten again."

Yesterday's swift rally in both the stock and bond markets was a reaction to the Fed's announcement that they've removed their bias toward tightening rates, after shifting the fed funds target from 4.75% to 5%. But the Fed's practice had generally been to shift to neutral -- it's just that until now, the market wouldn't find out about the bias until after the following meeting.

The Fed isn't necessarily finished, because they believe the current pace of growth will eventually cause price or wage inflation. The June NAPM survey, which increased to 57 from 55.2 in May, is more evidence of economic strength. A reading of 50 indicates expansion in the manufacturing sector, and eight of the report's nine components came in at 50 or greater.

The employment component fell to 51.9 from 53.5, but NAPM officials said a reading above 47 is generally consistent with growth in manufacturing payrolls, which hasn't happened in a non-strike influenced month since March 1998. The June

employment report

will be released tomorrow at 8:30 a.m. EDT, with economists calling for 220,000 in new nonfarm payrolls, according to


. The market's also looking for a revision to May's slim 11,000 gain in payrolls.

Jobless claims

have remained at historically low levels, which augers for a strong report. Claims fell to 299,000 for last week, and the four-week moving average dropped to 307,000.

"If it's a strong report, we could really fall apart, and revisit some levels we saw earlier in the week," Briggen said, referring to about 6.11% on the long bond.

If today's NAPM report was the market's final straw, the first straws were European in nature. Selling in the European bond markets, a product of weakness in the euro, caused selling in the market even before the market got a chance to look at the NAPM report.

"From what we were able to identify, there was sympathy selling out of Europe," said Ken Logan, managing analyst at

Thomson Global Markets

. "The portfolios underwater on the Continent decided to sell some Treasuries."

A number of technical reasons that contributed to yesterday's rally were responsible for the lack of followthrough buying today. Briggen said profit-taking in the short end of the curve was witnessed. For investors who bought the June two-year note auction with a coupon of 5.75%, it's a smart move -- today the note yields 5.58%. Since the two-year trades in anticipation of changes in monetary policy, if it looks like the Fed's going to raise rates, higher yields could be on the horizon. In addition, month-end buying also contributed to the rally, but with uncertainty surrounding tomorrow's employment report, investors don't want to buy the market heavily just yet.

Today's minutes revealed the Fed voted 11-0 at the May 18 meeting to leave rates unchanged.