Stock prices continue upward trend
The weaker-than-expected employment situation should have been damaging to equity investors on Friday. Instead, market players are becoming more optimistic about the economic outlook six months hence and are discounting unfriendly economic news. The day's damage was further limited by a positive early reading on consumer confidence.

All the major indices posted gains this week. However, the clear winner for the year - at least so far - is the Russell 2000, the index of small cap stocks. At Friday's close, the index stood at 99.5 percent of the December 31, 2000 close. The Dow Jones Industrials are following closely behind and the S&P 500 is within a reasonable "catch-up" range between now and the end of the month. However, the Nasdaq composite index will be lucky to see mid-year levels even if it continues at the current recovery pace.

Is something wrong with this picture?
Friday's employment report, showing greater-than-expected declines in payrolls, should have been friendly news for the bond market. Instead, market players focused on the University of Michigan's consumer sentiment index for early December that showed a very meager rise in confidence. (See chart below.) The yield on the 10-year note is up about 70 basis points from a month ago and the 2-year note is showing a similar rise.

The bond market has behaved oddly for more than a few weeks. Consider the fact that the yield on the 10-year note is about the same level it was around the first of the year, before the Fed reduced the federal funds rate target by 450 basis points. Inflationary pressures are not a problem and should not be a factor behind the high 10-year yield, while the Treasury's announcement on October 31, that they would indefinitely suspend issuance of 30-year bonds, should have increased demand for the note, thereby raising its price and reducing its yield.

Economists don't believe the Fed has completed its easing cycle. Even if the Fed brings the funds rate down to 1 percent by March, it is not likely to begin a tightening cycle during 2002. History shows that Fed officials want to ensure that an economic recovery is in place before they mop up excess liquidity by raising rates again.

The current situation in the Treasury market is a head scratcher.