Data Spur Fears of Tighter Fed
By RANDALL W. FORSYTH | MORE ARTICLES BY AUTHOR
Data could move the Fed to raise rates.
Only Months After The Federal Reserve took extra-ordinary steps to counter a potential meltdown of the global financial system, traders have begun to price in an increase in interest rates by the end of 2009. That stunning turnabout was precipitated by a single datum, a smaller-than-expected decline in payrolls reported for May.
The reversal sent Treasury yields soaring and interest-rate futures prices tumbling in heavy turnover Friday. Expectations the Fed will begin raising its target for overnight federal funds, currently 0% to 0.25%, later this year produced the sharpest increases in yields and declines in prices for short-to-intermediate-term Treasury notes.
The coupon maturity most sensitive to expectations for Fed policy, the two-year note, saw its yield soar Friday by an extraordinary 34 basis points (0.34 percentage points), to 1.30%, as anticipated Fed tightenings were discounted. Equally extraordinary was the price decline of 21/32, or $6.5625 per $1,000; doesn't sound like much except two-year note prices rarely budge more than 2/32 or so. By coincidence, the 30-year bond also fell 21/32, a more typical move for a long maturity, which is about nine times as sensitive to yield changes as the two-year note. This equivalent price change corresponded to a much smaller, four-basis-point rise in the bond's yield, to 4.64%.
The real damage was done in the "belly" of the yield curve, with five- and seven-year notes losing 1¼ points or more, also huge price moves for these maturities. Meanwhile, the three- and 10-year notes lost almost a point. That raised the 10-year note yield 12 basis points, to 3.84%, marking a six-month high for the benchmark note and indeed nearly the whole Treasury yield curve.
Based on the action of the fed-funds and Eurodollar futures markets, the Fed is expected to boost its key target to 0.5% by December and to 2% by the end of 2010. As recently as four weeks ago, the futures market had anticipated the funds target would remain around zero for the rest of the year and would rise only to 1% by August 2010, according to Michael T. Lewis, who heads the Free Market Inc. economic advisory in Chicago.
This shift in expectations came largely in reaction to the May jobs report that showed only 345,000 positions were cut from nonfarm payrolls, far less than the 500,000-plus sackings predicted by the consensus . The unemployment rate, derived from a separate survey of households, shot up to 9.4% from 8.9% in April.
According to Shadow Government Statistics' incisive analysis, May's payroll data were exaggerated by the so-called birth-death adjustment, which tries to account for new business formations. The Labor Department assumes that 220,000 more jobs came from this birth-death factor, 27% more than a year ago. Stripped of all statistical bias, SGS reckons last month's payroll drop would have been 538,000, or half-again what the Labor Department reported.
With the official government numbers showing a sharp drop in hours worked and negligible official pay gains, incomes aren't going to support spending gains. Meanwhile, consumers slashed their borrowing by $15.7 billion, the second-biggest drop on record after March's $16.6 billion decline. The rise in bond yields is pushing mortgage rates higher. All of which raises the question of where the growth will come from that will allow the Fed to tighten. |
