The Hindu Business Line : Bonds rally despite good US payroll

Despite the data beating expectations, the bond market, which normally would have fallen, anticipating a more aggressive interest rate policy from the Federal Reserve, rose strongly.

THE first Friday of every month is a big day for global financial markets because it sees the release of US employment statistics.

The data become the key driver of stocks, bonds and currencies not only in the US but also all over the world, including India. Last Friday was no exception.

The pre-data survey forecast 2.25 lakh new (non-farm) jobs in the US economy but, for the first time in three months, the actual number was an upside surprise.

Growth in payrolls was 2.62 lakh - well over one lakh more than in each of the previous two months.

Outlying predictions of gains of three lakh and even four lakh , based on the strong employment indices in business surveys, proved to be way off, but the figure was still very positive.

Disappointingly, the jobless rate gave contrary indications, rising to 5.4 per cent from 5.2 per cent - a sign of increasing numbers of people dropping out of the workforce.

Also wages were restrained, suggesting no increase in the disposable incomes of the employed and being somewhat negative for consumer spending.

Despite the data beating expectations, the bond market, which normally would have fallen, anticipating a more aggressive interest rate policy from the Federal Reserve, rose strongly.

Yields on 10-year Treasuries dropped about 10 basis points to 4.3 per cent levels.

Only earlier in the week, bonds took fright at the behaviour of what is believed to be Federal Reserve Chairman, Mr Alan Greenspan's preferred inflation indicator - the personal consumption expenditure index, stripped of food and energy - which rose 0.3 per cent in January, again exceeding the danger mark of 0.2 per cent.

One reason for the market's confidence on the inflation front - apart from Mr Greenspan's oft-repeated statement that "inflation is contained and inflationary expectations are anchored" - may be that there is no evidence of upward wage pressures.

Indeed, nominal wages have barely risen and real incomes have fallen.

On top of this, productivity for fourth quarter of 2004 was revised considerably upward. Unit labour costs are probably trending down making price increases less imperative.

The uptick in core inflation may well prove to be of the one-off variety.

The combination of decent job creation without, however, sparking off wage increases was tailor-made for a Wall Street rally.

The Dow Jones Industrial Average is in hailing distance of 11,000 - less than 10 per cent below its all-time high reached during the last boom.

The Federal Open Market Committee will have more data - retail sales, PPI and CPI - to chew on before it meets later this month.

Whether the meeting will signal a policy shift and more aggressive interest rate moves or not will determine the behaviour of markets in the coming weeks.

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