Inscrutably, Treasuries Reject Employment Report's Balm

And with the refunding and key inflation reports slated for next week, the outlook is grim.
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Defying the understanding of those who watch it all day long, the Treasury market tanked again today despite a friendlier-than-expected April

employment report.

The action underscored the high degree of fear that

Fed

Chairman

Alan Greenspan

struck into the hearts of bond investors with his

comments yesterday, which led many to conclude that the central bank is moving towards repealing at least one of the three interest-rate cuts it enacted last fall.

Based on the market's bad behavior, traders and analysts have little hope that the situation will improve before the end of next week. The Treasury auctions new 5- and 10-year notes next Tuesday and Wednesday in the quarterly refunding, and key inflation data gets released on Thursday and Friday in the form of the

Producer

and

Consumer Price Indices

.

As

yesterday's losses got extended, the benchmark 30-year Treasury bond's yield rose to the highest level in nearly a year. The long bond fell 9/32 to 92 3/32, lifting its yield 2 basis points to 5.81%, the highest since May 27. The 10- and the 5-year note also fell, but the 2-year note held steady, its yield at 5.17%.

Bewilderment was widespread.

"I can't explain interest rates," said Charles Parkhurst, co-head of government bond trading at

Salomon Smith Barney

. "I think it's absolutely out of control."

Treasury yields are "absolutely too high," he continued, given that the jobs report "should have been very salutary for the market." Nonfarm payrolls, the report's headline number, expanded by 234,000 in April, closely in line with the average forecast among economists surveyed by

Reuters

of a 230,000 gain. But widespread fear that the payroll figure would print north of 300,000 let the number masquerade as weaker-than-expected.

Another key component of the report was geniunely bond-friendly, however. Average hourly earnings, expected by the

Reuters

economists to rise 0.4%, rose only half as much, pulling the year-on-year rate of earnings growth down from 3.6% to 3.2%, the lowest in more than three years.

In the immediate aftermath of the report's release, Treasuries traded up sharply, with the long bond rising as much as 28/32 at 8:32 a.m. EDT. But even with the help of a coupon pass by the

Fed

in the late morning, the gains turned into losses as the day wore on.

Apparently, investors are afraid that Greenspan yesterday upped the odds that the Fed will shift its official bias from neutral to favoring a higher fed funds rate when it next meets on May 18, and convinced that today's numbers did nothing to change that.

Greenspan stirred up fear of a rate hike by discussing the degree to which the benign inflation environment is owing to factors that cannot be counted on to endure.

Even so, today's action is hard to explain. The Fed chief "did talk tough, no question about it, and he's the man," Parkhurst said. "But even with a tightening bias the market's oversold, particularly the long end."

"Why the market is not doing better is because the market is not paying attention to the numbers," concurred Richard Gilhooly, senior bond strategist at

Paribas Capital Markets

. "Eventually the market will start paying attention to the fundamentals, and the fundamentals" -- from the earnings component of the employment report to the

Employment Cost Index

to oil prices -- "look okay. But the market is concerned that Greenspan is going to raise rates."

"I was quite surprised," said Jim Kochan, senior bond strategist at

Robert W. Baird

in Milwaukee. "We had wonderful news in the morning and have done nothing with it. Worse than nothing. This is really a very, very depressed marketplace."

With the refunding and the PPI and CPI on the agenda for next week -- and with the stock market ignoring its woes, the Treasury market will probably continue to have a tough time, market-watchers say. Investors want to see continued calm in the core inflation measures, which exclude volatile food and energy prices, before they commit to the market, analysts say.

"If stocks start to break down, then maybe Treasuries can do well," Gilhooly said. "Otherwise we need to see those reports."