Data Non Grata Rip Bond Market

A stronger-than-expected report on labor costs and an ambiguous second-quarter GDP number have the bond market deeply depressed.
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Take THAT! And THAT! And THAT!

A trio of economic reports assaulted the Treasury market this morning, sending prices tumbling and yields leaping to their highest levels in a month.

The second-quarter

Employment Cost Index

in particular is forcing bond traders to price in a greater likelihood that the

Fed

will raise interest rates at its next meeting, Aug. 24.

The benchmark 30-year Treasury bond was lately 1 3/32 lower in price at 88 15/32, lifting its yield 9 basis points to 6.10%. The bond last closed at a yield that high on June 28. Shorter-maturity note yields are higher by roughly similar amounts, and the fed funds futures contract listed on the

Chicago Board of Trade

was lately pricing in a 72% chance of an Aug. 24 fed funds rate hike from 5% to 5.25%, up from 56% yesterday.

The ECI, the broadest measure of inflation in the labor market, rose 1.1% during the first quarter, vs. an average forecast among economists surveyed by

Reuters

for a 0.8% gain. It was the biggest increase since the second quarter of 1991. During the first quarter, the ECI advanced a below-trend 0.4%. The year-on-year pace of ECI growth advanced to 3.2% from 3% in the first quarter, but remains well below its third-quarter 1998 peak of 3.7%.

The wages and salaries component of the report rose 1.2%, vs. 0.5% during the first quarter, and the benefits component rose 0.9%, vs. 0.3% during the first quarter. Wages and salaries rose at their fastest pace since the second quarter of 1990, while the benefit increase was the biggest since the fourth quarter of 1997.

While statistical flukes account for a portion of the gains, "there are some genuine grounds for concern that wage inflation is accelerating,"

Barclays Capital

senior economist said in a research note. "Strong revenue growth has allowed some state and local governments to give their workers their first pay increase in years."

The increase in benefit costs, Willmore said, "probably reflects higher health-care insurance premiums." In short, he said, "There is plenty in this report to worry the Fed and we think it tips the odds in favor of a tightening at the Aug. 24

Fed meeting."

The day's other major economic report -- the government's first estimate of second-quarter

GDP

(two revisions will follow) -- was friendlier than expected on the surface. But beneath the surface it gives the bond market some cause for concern.

GDP grew at a 2.3% pace during the second quarter, the

Commerce Department

estimated. The

Reuters

consensus estimate was for a 3.3% rate.

The slower-than-expected pace of growth isn't comforting to bond traders for this reason: GDP growth slowed as much as it did not because consumer spending (the biggest component of GDP) slowed sharply, but because inventory growth (a smaller component) slowed sharply. Businesses, it appears, allowed their inventories to run off during the second quarter, which means they are going to have to rebuild them during the third quarter. The inventories component, which subtracted 0.9 percentage point from second-quarter GDP (much more than economists expected it to), has the potential to add as mightily to the third-quarter figure, the thinking goes.

"The question is, can we discredit the headline number based on consumption growth vs. inventories? And the answer seems to be yes,"

Miller Tabak Hirsch

chief bond market strategist Tony Crescenzi said.

As a final blow to the Treasury market this morning, the

Labor Department's

weekly tally of

initial jobless claims

slipped to 275,000 last week, the lowest count since the week of July 12, 1996. While the big swings in this series in the last few weeks have much to do with the auto industry's annual factory-retooling period, anything that smacks of labor-market tightness is data non grata in the bond market these days.