Treasury notes and bonds finished strongly higher as the market overcame some bearish sentiment in the early session. Yields, which move inversely to price, are near their two-year lows. Traders remain convinced the

Federal Reserve will trim interest rates once again by the end of the month.

"It would to be tempting to make today's rally sound more complicated than it really was. There were really two main factors affecting bond performance -- the weakness in equities and the rumor of financial distress in California, owing to the problems in utilities," said Sadakichi Robbins, bond portfolio manager at

Julius Baer

.

Robbins was referring to the flutter caused in morning trading when news spread that

Bank of America

would announce derivative losses due to a default on unsecured loans it had made to California utility companies. Bond rater Standard & Poor's has indeed lowered the debt rating on two of them to BBB. Although Bank of America denied the rumor, its denial did not come soon enough to prevent the equity market from falling sharply or to keep Treasuries from shooting upward.

Unemployment data, the major news event of the day, didn't come out as dire as feared, but the money market's mood remained unchanged about the slowing economy. Some analysts are guessing that the currently available payroll and unemployment information will be revised and that next month's report will be a lot worse.

"The unemployment report wasn't as bad as expected, but there is a weakening trend in the underlying picture. After the significant correction that we saw in the bonds owing to the Fed rate cut, the money market is gaining momentum again," added Robbins.

The benchmark 10-year

Treasury note rose 30/32 to 106 6/32, lowering its yield 12.2 basis points to 4.921%.

The 30-year

Treasury bond rose 22/32 to 112 14/32, lowering its yield 4 basis points to 5.399%.

At the

Chicago Board of Trade

, the March

Treasury futures contract rose 15/32 to 105 19/32.

Ray Remy, Treasury market strategist at

HSBC Securities

, thought the market did much better through the latter part of the day but could not pinpoint the reason. "There are some flight-to-quality concerns, but other than that I cannot find a real reason for the way it moved," he said. "Flight to quality" behavior refers to investors shifting their assets from poorly performing investment vehicles to safer choices. Stocks and other equity instruments have been suffering repeated losses lately, resulting in the transfer of holdings to the money market.

"Even during the temporary equity rally that took place after the Fed's interest rate cut, the technically driven investors bought on key support levels. From their intentions, others who had become shy of fixed income securities then jumped on the bandwagon as well," said Robbins, as he explained the Treasuries' progress in recent sessions. "Mortgage investors are also buying into the bond market to maintain the strength of their portfolios."

Managers of mortgage-backed security portfolios are anxious that lower interest rates will accelerate home refinancing and early prepayments of mortgage loans. This would force them to reinvest in funds at less attractive interest rates.

Regarding further Fed moves in January, Robbins agrees with "the 95% who believe the central bank will take down the fed funds rate 50 basis points by the end of the month. In fact, 25 basis points have been already been priced in by the fed funds market." The federal funds rate is the interest rate at which banks lend to each other overnight. "The Fed will want to get quickly to 5.5% in January since their next

FOMC

meeting is not until March," he added.

Anticipating other economic reports for the month, Robbins said, "The retail sales report is very important. It will be the final determination of the Christmas season, which seems to have been moderately weak. Wage data is going to tell us of inertia in the inflation effect. The Producer Price and the Consumer Price Index reports are going to be largely ignored even if they come slightly above the trend."

"We might see a little bit of a turnaround in the housing data because of interest rate sensitivity. But the consumer confidence report will be significant because that is going to touch on some critical issues about the economy," he concluded.

Economic Indicators

In economic news, the

employment report

(

definition |

chart |

source

) had nonfarm payrolls, which are new jobs created during the month, rising by 105,000 in December. This is the slowest rate since August. The government accounted for more than half of this growth, while privately held manufacturers continued to lose jobs. The unemployment rate remains at 4%, slightly better than expected. Economists polled by

Reuters

had forecast it at 4.1%.

The augmented unemployment rate rose to 7% in December as compared with 6.9% the previous month. It differs from the regular unemployment number by also counting those of the unemployed who are not actively looking for a job but will begin working again if offered one.

The average hourly earnings increased 0.4%, little more than expected, as the annual rate edged up to 4.2% from 4.1%. This is the fastest advance in two years.

New home sales

(

definition |

chart |

source

) fell 2.2% to 909,000 in November from 929,000 in October, a bigger drop-off than predicted. Due to the low mortgage rates, economists had expected the number to come in at 913,000. New home sales have now declined for the third consecutive month but sales remain well above the level they had dipped to last summer.

Currency and Commodities

The dollar rose against the yen and fell against the euro. It lately was worth 116.53 yen, up from 115.73. The euro was worth $0.9578, up from $0.9490. For more on currencies, see

TSC's

Currencies column.

Crude oil for February delivery at the

New York Mercantile Exchange

fell to $27.86 a barrel from $28.14.

The

Bridge Commodity Research Bureau Index

rose to 228.53 from 227.23.

Gold for March delivery at the

Comex

rose to $268.90 an ounce from $268.40.