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Inflation Numbers Deflate Bonds

The jump in the Employment Cost Index and the GDP deflator pops the bond market's minirally balloon.

Whoops!

Thursday's inflation news did bond prices no good. The only plus for fixed-income traders, and a transitory one at that, was the decline in stocks.

Thursday's release of the

Employment Cost Index and

GDP price deflator was not fundamentally good news for bonds. Treasury bonds and bills sold off when the news was released at 8:30 a.m. EDT, but came back when traders saw that stock index futures were getting crushed before the opening in New York. At that point, more than a few folks jumped into fixed income as a defensive measure.

Flight-to-quality or no, the expectation of higher inflation is bad for holders of fixed-income instruments. Thursday's news suggests to bond analysts and traders that the

Fed

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will raise short-term interest rates more than had been previously expected. Logically enough, the short end of the Treasury yield curve was hit hardest with yields on the two-year, for instance, up 7 basis points to 6.58% by midmorning. Ten-year yields were rising in lockstep. The 30-year bond fared better, but mainly because the Treasury had announced a large buyback for Thursday at 11:00 a.m EDT.

Thursday's depressing news for bond investors comes after a minirally that began in the first part of the year. The rally had been based on hopes that increasing U.S. labor productivity would dampen wage inflation even as real growth plowed ahead. (God knows that bond investors could have used some relief after 1999 -- one of the worst bear markets for guvvies in 30 years. Bond prices dropped consistently. That was the pattern pretty much from October 1998 until last January when the yield on the 30-year reached a high of 6.75%.)

The 2000 rally is dead for now, according to

Prudential Securities'

Richard Taglianetti, a senior vice president for investments who specializes in bonds. "There is no reason to think that the bear market we saw earlier has ended," he said. "Wage inflation seems to be picking up and

Greenspan

has made no secret that he will continue to tap the interest rate brakes. If inflation is picking up and short-term rates are going up, you don't want to hold as much fixed-income paper as you did yesterday."

Bond prices remain down across the board.