Bonds Shake Off Meyer but Still End Down

A benign manufacturing sector report enabled the Treasury market to pare its heavy early losses.
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Bond prices pared the steep losses they suffered early in the session on hawkish comments by an equally hawkish


official, but still ended the day lower, extending the downtrend they have been in since Nov. 16.

Relief from Fed Governor

Laurence Meyer's

cautionary comments came in the form of the November

Purchasing Managers' Index

, which turned in a friendlier-than-expected performance.

Still, the benchmark 30-year Treasury bond ended the day down 4/32 at 97 22/32, lifting its yield a basis point to 6.30%, its highest since late October. Shorter-maturity Treasury note yields rose by comparable amounts. It was the Treasury market's ninth down day in the last 11.

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Now, analysts expect very little noise out of the Treasury market until Friday morning, when the Labor Department releases the November

employment report

, the most important monthly economic indicator.

The long bond fell as much as 26/32 this morning on Meyer's

comments at

New York University's Stern Business School

last night. Meyer, whom Fed-watchers consider the most hawkish member of the Fed's monetary policy committee, made two statements suggesting that additional interest-rate hikes may be necessary.

In the first, he said that while rising productivity has lowered the NAIRU -- the non-accelerating inflation rate of unemployment, the unemployment rate below which inflation accelerates -- "old rules still apply to the new limits. Overheating still eventually results if the growth of demand exceeds the growth of supply for long enough, driving the unemployment rate below the NAIRU. Excess demand in labor markets still ultimately puts upward pressure on nominal compensation."

In his second headline-grabbing statement, Meyer said: "Once the unemployment rate falls far enough below your best estimate of the NAIRU, for example, it would be prudent to return to a more normal responsiveness of interest rates to further declines in the unemployment rate. In my judgment, we are already in a range in which such a normal response to further declines in the unemployment rate is warranted."

At the

Chicago Board of Trade

, where futures contracts on the fed funds rate are

listed, traders today boosted (to 70.9% from 62.3%) the implied likelihood of a rate hike to 5.75% from 5.5% at the Fed's Feb. 1-2 meeting.

Futures traders believe there is almost no chance that rates will be hiked at the next Fed meeting, scheduled for Dec. 21.

The magnitude of the reaction to Meyer surprised different analysts for different reasons.

"He conceded that because of uncertainty

about whether the forces that have allowed growth to accelerate without accelerating inflation, you don't want to tighten as aggressively as you would normally," said Henry Willmore, senior economist at

Barclays Capital

. "There are stylistic differences between


and him, but what they're saying is pretty similar."

Others focused on Meyer's reputation as an unreconstructed inflation hawk, solidified in a January 1997

speech in which he declared that either growth would slow or inflation would heat up.

"I can't believe we even reacted,"

Warburg Dillon Read

Treasury market strategist Mark Mahoney said. "He's been making the same speech everywhere forever. I don't get why the market would pay that much attention."

Fortunately, the Purchasing Managers' Index provided a reprieve. The index itself, which signals manufacturing sector expansion when it's over 50, was in line with expectations, dropping to 56.2 in November from 56.6 in October. More importantly though, a companion index that measures prices paid by manufacturers retreated to its lowest level since August. The Price Index dropped to 65.3 from 69.4.

The development was especially important because

yesterday, the price component of the

Chicago Purchasing Managers' Index

, a regional version of today's report, rose sharply. "After the Chicago number, people were really worried about what the Purchasing Managers' was going to look like," Mahoney said.