Treasury Yields to One-Month Lows on Small Wage Gain

The October employment report showed that inflation remains well contained.
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An absence of wage inflation in the October

employment report

triggered the seventh Treasury market rally in the last eight sessions, as traders concluded that there is no pressing need for the

Fed

to hike interest rates later this month, because there is no inflation problem.

The big rally carried yields to their lowest levels in over a month. Yields are down sufficiently from the two-year highs they made less than two weeks ago, that even people who think yields have higher to go before the bear market ends are firmly convinced that they won't go any higher this year.

The benchmark 30-year bond ended the day up 21/32 at 100 31/32, trimming its yield 5 basis points to 6.05%, the lowest since Sept. 20. Shorter-maturity note yields shed 3 to 4 basis points.

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The news that

average hourly earnings

-- a component of the jobs report -- advanced only 0.1% was the catalyst for the rally. Economists surveyed by

Reuters

had forecast a 0.3% gain, on average.

The weak rise in earnings reinforced the notion that despite a 30-year low unemployment rate and a slowdown in the pace of jobs growth that could as easily reflect a shrinking pool of available workers as a braking of economic growth, the U.S. economy is not at risk of accelerating price inflation.

The unemployment rate, as measured by the jobs report, fell from 4.2% to 4.1%, the lowest since January 1990.

As for jobs growth, the economy added 310,000 nonfarm jobs in October, almost perfectly in line with the 313,000 average forecast. While that's well above the recent trend, September payrolls grew at a substantially below-trend rate due to Hurricane Floyd. The average gain over the two months -- about 175,000 -- suggests a slowdown. During the first eight months of the year, payrolls grew by an average of 220,000 a month.

The numbers led many on the Street to conclude that the Fed is unlikely to hike interest rates again this year, at either of its last two meetings of the year. The Fed is scheduled to meet on Nov. 16 and again on Dec. 21.

The Dec. 21 meeting was always considered an unlikely candidate for a fed funds rate hike because of its proximity to the end of the year. Today, the odds of a Nov. 16 hike slipped markedly.

At the Chicago Board of Trade, where options on the fed funds rate are

listed, the odds of a Nov. 16 hike implied by the November contract's price slipped to 34% from 43% on Thursday. As recently as Tuesday, the implied odds were over 50%.

A Nov. 16 rate hike can't be ruled out, analysts say. Of 30 primary dealers of Treasury securities polled by

Reuters

today, 12 are still predicting one. And nearly all expect the fed funds rate to stand at at least 5.50% by the middle of next year.

The Fed has nothing to lose by hiking rates this month, and potentially more to gain by downgrading the risk that inflation will rise over the next six months, the argument goes. And the October jobs report, average hourly earnings notwithstanding, gives the Fed plenty of cover to hike if it is inclined to do so,

Warburg Dillon Read

economist Jeffrey Palma observed. The unemployment rate argues in favor, as does the shrinking pool of available workers -- people who aren't counted among the unemployed, but who want jobs.

But today's market action clearly suggests that market participants are giving more credence to the counterargument: That the Fed is under no pressure to hike rates this year, and would just as soon wait till its first meeting of the new year, on Feb. 1-2, and see whether higher rates are more clearly called for at that time.

Even if the Fed stands pat this month, the Treasury market action of the last week-and-a-half reflects a fair amount of wishful thinking, as some see it.

"I don't think two increases in the fed funds rate are enough to slow what's become a very strong expansion," said Jim Kochan, bond market strategist at

Robert W. Baird

in Milwaukee, who expects a 6% fed funds rate and a 7% long Treasury yield by the middle of next year before the bear market is over.

"Every year at this time, for the last four years, we've heard the analysis that the economy's slowing, and bonds rally," Kochan said, noting that over the last 20 years, the bond market has performed better in November than in any other month of the year, by far. "Then, in January and February we see some stronger numbers and the bond market sells off."

In the nearer future, the Treasury market is counting down to the Fed meeting a week from Tuesday. Along the way, its main challenge is probably supply. Next Tuesday and Wednesday, the Treasury Department will auction new five- and 10-year notes in its so-called quarterly refunding. And this week's drop in interest rate may entice corporate bond issuers to market, providing competition for Treasuries.