Market Commentary

In late trading, the 10-Year Treasury Note was down by 5/32, raising its yield by 2 basis points to 3.89%; the Dow was up by 73.03 points to 11,288.54; and the Nasdaq was down by 6.08 points to 2,245.38.

Today's release of the employment report for last month showed a larger than predicted decline in nonfarm payrolls and the unemployment rate did not decline as expected.

While this would normally provide lift for bonds and depress stocks, a weak report on private payrolls yesterday from Automatic Data Processing prepared traders for the Labor Department numbers. Stocks fell sharply yesterday and Treasuries made sizeable gains.

Yesterday's market moves may have been seen as exaggerated. The payroll decline for June in the ADP report was the largest in over five-and-a-half years and some traders may have been surprised that today's report was not worse than it actually turned out to be.

Another weak economic indicator released this morning was the ISM Services Index. It showed a contraction of activity last month, though analysts had predicted a slight expansion.

Though the longer-dated Treasuries remained in the red today, the shorter maturity notes did get a mild lift from the economic data. Bearish data will tend to keep the Fed on hold regarding short-term interest rates, instead of hiking them.

Oil prices played a role in the performance of stocks. While the price rose again today, it declined substantially from its intraday high. After being up to almost $146.00 per barrel, the August contract on light, sweet crude closed at $145.29. This was still up by $1.72 from yesterday's close and it was a new record high, but the retreat from its earlier level eased some of the pressure on stocks. By the end of stock trading, the Dow had gained 0.65% on the day and the S&P 500 edged up by 0.11%. The Nasdaq lagged with a loss of 0.27%.

Despite the Dow's gain today, it fell by 0.51% for the week and is down by slightly more than 20.0% from its all-time closing high of 14,164.53, posted last October 9th. The S&P 500 lost 1.21% on the week and the Nasdaq posted a loss of 3.03%.

The benchmark 10-Year Treasury Note was nearly unchanged for the week. Its yield gained 1 basis point (yield moves inversely to price). The yield had fallen by 20 basis points last week and some market watchers were looking for a round of selling this week that would have more substantially pushed up the yield. But the ongoing move out of stocks kept Treasuries supported.

Next week's calendar of events starts off slowly and trade is likely to remain thin on Monday. Market participants may decide to stay on the sidelines since there are no major economic releases scheduled.

Tuesday brings a couple of second-tier releases. The National Association of Realtors' pending home sales data is always somewhat dated and its significance is as an indicator of upcoming actual sales. The data was first published in 2005 with data going back to 2001. The index is a measure of contract activity and the NAR asserts that 80% of contracts become sales within two months and a large portion of the rest become sales two months thereafter.

The sales index rose by 6.3% in April, a much stronger reading than observers were expecting. It had declined by 1.0% in March following a 2.8% drop in February. April's index was the highest since last October and the jump was the strongest in five years. Declining home prices are being cited as the reason for the renewed buying interest.

Despite the spike in April's pending home sales index, the housing sector is still weak and forecasters are looking for a decline in May of about 3.0%.

Also out on Tuesday is the report on wholesale inventories for May. Like the pending home sales report, the inventory data is also somewhat dated. Moreover, the data provides an incomplete picture of the inventory situation. A comprehensive report -- which includes the manufacturing, wholesale, and retail sectors -- will be released on the 15th.

In the last wholesale inventories report, the Commerce Department said that the seasonally adjusted level of wholesale inventories rose in April by 1.3%, a much stronger increase than the 0.5% that had been predicted. Not only did inventory levels rise but sales increased by 1.4%. This pushed the inventory-to-sales (I/S) ratio down to 1.09 from March's 1.10.

The I/S ratio is the value of stocks on hand at the end of a month divided by the value of sales for the month. It indicates how many months it would take to entirely deplete existing inventory at the prevailing sales pace. Low turnover times mean there is high pressure to replace supplies and it is, therefore, a positive economic indicator.

There are no major releases slated for Wednesday so the weekly mortgage application data from the Mortgage Bankers Association and the oil inventories report from the Energy Information Administration will get extra attention. Both mortgage applications and crude oil inventories have been slumping lately.

The employment situation gets another review on Thursday when the jobless claims report is released. The level of initial and continuing claims has been trending up as the job market has gotten smaller in response to the faltering economy. Today's report showed a hefty jump in initial claims last week to near the highest level in almost three years. The level of continuing claims declined in the week ending June 21, but the four-week moving average hit a better than four year high.

Following the latest jump in the initial claims figure, a modest retreat is anticipated for this week. Any larger than anticipated move in either direction would likely be viewed skeptically as a fluke related to the Independence Day adjustment factor.

Supply will present an obstacle to bonds on Thursday morning as traders prepare for the Treasury's auction of 10-Year Treasury Inflation Protected Securities (TIPS). TIPS are government debt securities that have a fixed coupon (interest) rate, but their face value is regularly adjusted according to the Consumer Price Index, so the interest payout amounts fluctuate according to the changes in inflation. At maturity, the greater of the inflation-adjusted or original redemption value is paid out.

In the current auction schedule (begun in July of 2003) a new 10-Year TIPS issue is offered twice a year but three months after each initial offering, an additional amount of the issue is sold so there are two initialand two reopening auctions each year.

Thursday's is an initial offering. The last one was in January and it received lukewarm demand. Bids exceeded the $8 billion offer by 1.90 to 1, a lower bid-to-cover ratio than the 1.97 in July's auction (the last initial offering) but slightly higher than the average of 1.87 for the nine initial auctions in the current issue schedule prior to January's.

Noncompetitive bids, a gauge of individual investor demand, totaled $96 million, up from $71 million in July. But foreign demand was weak. Indirect competitive bids, which include those from foreign central banks, garnered 29.9% of the issue, the lowest award portion of the ten initial offerings in the current schedule.

Friday is a busy news day. The first couple of releases are trade-related. The report on import and export prices for last month will reveal the impact trade is having on inflation. In the last report, the Labor Department said that the seasonally adjusted index of import prices rose by 2.3% in May. April's originally reported increase of 1.8% was revised up to 2.4% and March's previously reported increase of 2.9% was revised up to 3.0%. As might be expected, the rising price of oil is a major contributor to the increases. Imported petroleum product prices rose by 7.8% in May, by 5.9% in April, and by 9.8% in March.

Excluding oil, import prices were up by 0.5% in May, the smallest increase since last December. While this might seem to offset the effect of the headline figure, the price of oil is an inflation factor that is getting harder to overlook.

Since the price of oil continued to rise in June, another substantial increase is predicted for overall import prices. Current forecasts call for a rise of about 1.8%.

The last report said that export prices were relatively well contained in May. Overall, they were up by 0.3%, the smallest advance since last September. Excluding the large but volatile category of agricultural products, export prices were up by 0.4%, the smallest increase since December.

The other report is on international trade for May. According to the Commerce Department, the seasonally adjusted level of imports exceeded that of exports by $60.9 billion in April. The deficit was larger than the $59.5 billion to $60.0 billion that had been predicted, but data revisions trimmed about $1.0 billion from the totals in each of the previous twelve months.

March's originally reported deficit of $58.2 billion was revised to $56.5 billion. But the April's gap was the largest since March of last year when it was $62.5 billion.

Both the total import and export levels were the highest on record. Exports grew by 3.3% while the larger import category grew by 4.5% from March to April. Somewhat paradoxically, the jumps in both imports and exports were due to the falling value of the dollar relative to other currencies.

A weaker dollar makes US exports cheaper to foreign buyers and helps attract demand. But foreign oil is priced in dollars and when the value of the currency declines, producers increase the price of oil and thevalue of crude oil imports hit a record high in April.

With oil prices hitting new highs in May, the trade gap is expected to have widened to about $62.0 billion -- a thirteen month high.

Also out on Friday morning is the first read on consumer sentiment from the twice monthly surveys conducted by the University of Michigan. In the final read for June, the overall sentiment index came in at 56.4, the lowest reading since May of 1980. The sharp decline in stock prices, the high cost of gasoline, and the shrinking labor market contributed to the pessimism. With no improvement in those factors, the preliminary index for July is not expected to show any improvement and may show some further deterioration.

The last release of the week will be the budget report from the Treasury. In June of last year, government receipts exceeded outlays by $27.5 billion. For last month, a stronger surplus of $36.5 billion is predicted. Part of the reason for the forecast is that May's deficit of $165.9 billion was much larger than anticipated and may have been due to calendar issues that will find some compensation in the succeeding month.

But even with a better surplus figure for June, if the prediction is accurate, the total to date for the fiscal year (begun last October) would be a deficit of $281.5 billion. For the same period in the 2007 fiscal year, the deficit was just $121.0 billion.

Large deficits weigh against Treasuries since it means more of the securities will have to be auctioned in order to cover the debt and keep government operations running. More supply dilutes demand and the possibility of higher coupon values in future issues means current securities prices have to be reduced in order to compete.

10:30 AM EDT : Treasuries began the day with losses as some traders were inclined to take back some recent profits. But the market has pared losses as the economic data released today was weaker than expected, oil prices continue to climb, and stocks continue to fall.

Weak economic news usually weighs against stocks and the Dow was down earlier by over 100 points. The shift out of equities often benefits bonds as does the interest rate implications of bearish news.

But stocks have recently shown some strength as oil prices have been retreating from earlier highs. In overnight trading, the price of a barrel of crude oil for next month delivery rose as high as $145.85 or $2.28 above yesterday's close on the New York Mercantile Exchange. It has since pulled back and in recent trading the price was up by just $0.07 at $143.64.

In the big news of the day, the Labor Department said that the seasonally adjusted level of nonfarm payrolls fell by 62,000 in June and May's originally reported decline of 49,000 was also revised to a decline of 62,000. In addition, April's previously reported decline of 28,000 was revised to a drop of 67,000. Forecasters had been predicting a decline in June of between 50,000 and 60,000.

The goods producing sector continued to shed jobs. Construction payrolls fell by 43,000 and in manufacturing, they fell by 33,000. This marked twelve straight months of declines in construction and twenty-four in manufacturing.

But the services sector also saw widespread losses. Payrolls fell by 51,000 in the business and professional services category, by 10,000 in the category of financial activities, and retail trade saw a drop of 7,500. The strong sectors were education and health, which saw a gain of 29,000, and leisure and hospitality, which saw a gain of 24,000. The increase in education and health increase was a forty-fifth consecutive monthly expansion and the rise in leisure and hospitality was a twenty-fifth consecutive increase. Government payrolls expanded by 29,000 last month.

Another bearish detail in today's report was that the unemployment rate, the portion of the workforce without jobs, remained at 5.5% in June instead of easing back somewhat as analysts had predicted. The jump in May from April's 5.0% was the largest in twenty-two years and the level in the last two months has been the highest since October of 2004.

The inflation news in the employment report was benign. Average hourly earnings rose in June by 0.3%, in-line with the average of the last several years.

In a separate report, the Labor Department said that the seasonally adjusted level of initial jobless claims rose last week by 16,000 to 404,000. At the end of March, the level reached 406,000 but other than that, last week's level has not been topped since the week ending September 17, 2005. A level over 400,000 is seen as a sign that hiring is not keeping up with layoffs.

The four-week moving average, which smoothes out short-term volatility, rose last week to 390,500, the highest reading since early October of 2005. In the twenty-six weeks of the year to date, the average weekly initial claims reading has been 362,769. For the same period last year, the average reading was 315,654.

The report said that the level of continuing claims for the week ending June 21 (continuing claims must be at least a week old) fell by 19,000 to 3.116 million. But this was still the third highest reading since February of 2004. The four-week moving average rose by 8,750 to 3,110,750, which was the highest reading since then. The average weekly continuing claims reading in the twenty-five weeks of data for the year so far has been 2,924,200. In the same period in 2007, the average was 2,507,960.

The last economic release of the day was also more bearish than expected. The Institute for Supply Management (ISM) said that its non-manufacturing index (NMI), a gauge of activity in the services sector, came in at 48.2 for June. Any reading below 50.0 indicates a general contraction of activity relative to the preceding month. The index reading for May was 51.7 and analysts had predicted a reading of 51.5 for last month.

The NMI is new -- first published last January. It is a composite of four seasonally adjusted indices: business activity, new orders, employment, and supplier deliveries. Before the NMI was instituted, the business activities index was the headline indicator on the services sector, but it is derived from a single question in the survey of business purchasing managers.

Last month's NMI was the fourth contraction reading of the year so far and even the business activities index posted a slight negative reading of 49.9 last month. This was down from 53.6 in May.

Bond trading will be abbreviated today since the Securities Industry and Financial Markets Association has recommended an early close (2.00 PM Eastern Time instead of 3:00). All domestic markets and government offices will be closed on Friday in observance of Independence Day.

Bond trading volumes will thin today as the session progresses. The reduction of liquidity could result in erratic price movements . . . .