Updated from 12:28 p.m. EST The yield curve inverted again Thursday, with Fed watchers fretting that labor market strength in Friday's jobs report could mean at least one more interest rate hike in March. "We're essentially unchanged on the day ... and the market is positioned short before the
January payroll number," says Rick Klingman, chief Treasuries trader at ABN Amro. Wall Street estimates are looking for the January payroll report to show that employers added 250,000 workers, compared with 108,000 jobs created in December. The benchmark 10-year note was flat on the day to yield 4.56%, while the 30-year bond gained 6/32 of a point to yield 4.69%. Prices and yields move in opposite directions. The five-year note was unchanged to yield 4.50%. The two-year note was also little changed and was yielding 4.58%, 2 basis points more than the 10-year yield. Longer-dated maturities usually yield more to compensate investors for taking on the additional risk of a longer-term loan. When yields on the short end rise higher, "inverting" the curve, it could mean that investors see more risk in the near term, a perception that has historically preceded an economic slowdown or recession. A morning report on weekly jobless claims ramped up speculation that Friday's payroll number will come in at or above Wall Street expectations. Initial claims for unemployment benefits unexpectedly fell by 11,000 to 273,000, vs. expectations for claims to rise to 295,000, according to a report from the Department of Labor. The decline also leaves the four-week moving average at 284,000, the lowest level since June 2000. "The continued low level of jobless claims is leading people to believe that the labor market is fairly strong," says Klingman. Fed officials have hinted in speeches past that they are carefully monitoring the employment picture because the U.S. is close to "full employment," or the lowest level of unemployment possible before wage inflation sets in. Bond traders loathe inflation because it erodes the value of fixed-income investments.
Other strong employment-related indicators released in the morning included a report from the hiring firm Challenger, Gray & Christmas that said corporate layoff announcements declined by 4% from December to January. But layoff announcements over the period were still up 12% year on year. And the Monster employment index, which measures online recruitment, rose 4%. "The data really is not too threatening, but firm enough," writes David Ader, U.S. bond strategist at RBS Greenwich Capital, in a research note. He points out that yesterday's ISM manufacturing index slipped a bit but that the price component went up. "This represents our biggest economic concern, slower growth but more price pressure and a scenario that keeps the Fed
raising interest rates," Ader writes. On the other side of the ledger, a preliminary reading on fourth-quarter nonfarm productivity and costs showed that productivity fell by 0.6%, vs. forecasts for productivity to rise by 1.0%, which could show that the economy is weakening. This would be in line with signs of softness in last quarter's disappointing GDP report, which posted startlingly low 1.1% growth. However, economists at Barclays believe that isolated weakness in the more recent GDP report will give way to a stronger first-quarter reading. Klingman agrees, saying, "The GDP number didn't line up well with the rest of the numbers, and I think it was looked at with a certain amount of doubt." He expects that not only will first-quarter GDP look strong, the fourth-quarter number will be revised higher. The market has until March 28 to adjust before the next Federal Open Market Committee meeting and possible rate hike. It may get a clearer picture of where interest rates are heading on Feb. 15, when Ben Bernanke testifies before Congress in his first public outing as Federal Reserve chairman.
The upcoming Treasury sales have weighed on the market since the government announced on Wednesday that it will sell $48 billion in debt for its quarterly refunding. A huge amount of supply has already hit the market. Hospital operator HCA ( HCA) said Thursday it plans to sell $1 billion in 10-year high-yield bonds, while Linens 'n Things ( LIN) said it may sell $650 million worth of bonds to help cover the costs of its leveraged buyout by Apollo Management. Of particular interest to the market is a debate over how popular the 30-year issue will be; Feb. 9 will mark the first 30-year auction since 2001. The 30-year's afternoon rally implies that the market was sticking with the old paper, rather than waiting to pick up the new issue, says Steve Bohlin, portfolio manager at Thornburg Investment Management. But by the end of the session, the 30-year had lost most of its ground and the debate resumed. Foreign central banks, which have been buying longer-dated debt and keeping yields low, "don't necessarily need to buy the long bond anymore," says Bohlin. "If you look at the massive amount of China's and Japan's reserves that are held in dollars, the issue is this: Do they really need more?" Bohlin says that while no one can know the answer until the auctions, there are other options for foreign central banks, including buying at the short end of the curve, buying euros or the yen, or even getting into gold.