Rates could be quite a bit higher than expected had the bond market continued to take the cue from the unanticipated high Unit Labor Cost. Unit Labor Cost were anticipated to be +3.0% to +3.6%. The Department of Labor stated that Unit Labor Cost were +6.6%.

It is surprising that the bond market mostly ignored this number, but we are glad that it did. We think that the stabilizing stock market may be part of the reason that the bond market has ignored this number.

The Unit Labor Cost is an attachment to the quarterly Productivity report. The market was expecting Productivity to be +1.5% to +2.0%. The Labor Department reported productivity at +1.6%.

The only economic item that bonds responded to, albeit tepidly, was the Factory Orders report. Economists were looking for a -1.8% to a -5.0%. (The -1.8% was far out of the range; most were -3.5% to -5.0%.) Factory Orders actually fell by -5.6%.

There were items out that are mostly ignored by the bond market, but can give some clues to the items that the market will notice. Both Redbook Retail Survey, and UBS Store Sales Index seem to be trending lower in their weekly reports. UBS Store Sales week-to-week comparison was -.4% and year-to-year was 1.5%. Redbook’s year-to-year was only 2.9%.

January’s Pending Home Sales was -4.9%. This may mean we could see a lower report for February’s Existing Home Sales report on 23 March.

TOMORROW, 07 MARCH 2007

All of tomorrow’s data is of a low-importance level.

The only item with any predictions is the Consumer Credit report at 14:00cst {2:000p.m for those who can’s subtract by 12, 20:00gmt}. The predictions range widely from +$5.0b to +$10.0b. The range is somewhat higher than last month’s $6.0b.

Beige book had impacted rates about ten years ago, but in the past half decade are usually treated with a yawn from bond markets. That can still turn and there is the slim chance it will tomorrow at 13:00cst {19:00gmt}.

The market will open digesting the ADP Employment Index morsel. The ADP national employment report is computed from a subset of ADP records that in December 2005 covered 14 million employees at roughly 225,000 business establishments. ADP contracted Macroeconomic Advisors to compute a monthly report that would ultimately help to predict monthly non-farm payrolls from the Bureau of Labor Statistic's employment situation. The ADP report only covers private (excluding government) payrolls at this time. It has affected bond rates on occasion. There are no predictions, last month the report showed an increase of 111k.

The market also opens with the weekly MBA Purchase Application Index which has on rare occasion influenced rates. Given the weekly nature, most analysts watch the 4-week moving average as it mellows the volatility out some.

The weekly Crude Inventories are published and need to be watched as energy prices rise. It is possible that they will get to the point where inflation, and therefore interest rates take notice.

[Publisher’s note: With the exception of Saturday, we will publish only one of the outlook sections each day on a rotating basis, none on Friday. SHORT-TERM OUTLOOK (on Monday) attempts to forecast and discuss up to the next 30 days. MID-TERM OUTLOOK (on Tuesday) looks forward from 15 to 90 days, most often 30 to 90 days. The Mid-term has the most accurate predictions, just like the weather. The LONG-TERM OUTLOOK (on Thursday) will extend out the next six months, maybe one year. When we change an outlook section we will embolden the date and heading.]

MID-TERM OUTLOOK [10 February 2007]

We are not as optimistic on rates for the remainder of the 1^st quarter. As homeowners start to see a rebound in housing their confidence will increase. As confidence increases, so will spending. That will bring back inflationary fears.

The good news is the bond market’s reaction to the Treasury Auctions of the week of 05 to 09 February. In each case there was heavy demand, especially for the longer term bonds. It is apparent that bond investors are still of the mind that inflation is whipped, and-or the economy is slowing. They may be right on the first issue, but probably not on the second.

At this time, the bond market appears to prefer lower rates. This is not always true, but is for now. George Goncalves, a fixed-income strategist at Banc of America Securities LLC in New York, explained the situation best when he was quoted in Bloomberg.com “`Every time the market tries to do something, we get good economic data that suggest yields are heading higher,'' said one of the 22 primary dealers that trade with the Fed. “

The majority of economists seem to see the FED on hold for the next few months. That could be good given that the bond market has a desire to keep long term rates below the FED-Funds rates.

Stephen Stanley, RBS Greenwich Capital was quoted in the Wall Street Journal, “The tweaks at the margin argue for less risk of a move in either direction. So the Fed is on hold for a while with a slight lean toward hiking, whereas the market has the Fed on hold for most of the year with a slight lean toward an ease late in the year.”

But there is still some concern for inflation. Bear Stearns Economics said, “If GDP growth continues above 3%, as we expect, and if core inflation pressures show any sign of creeping higher, this statement leaves the Fed flexibly positioned to raise rates before the middle of the year. If January data on employment and retail sales suggest that the economy continued at an above-trend pace, then Bernanke could adopt a more hawkish tone on Feb. 14 (when he delivers his semiannual testimony on monetary policy and the economy to Congress). Our expectations for the Fed's central tendency forecasts for 2007 are 2¾% to 3% on real GDP growth and 2% to 2¼% on core PCE price inflation.”

Regardless of what the FED does within its FOMC, the bond market will react to changes in inflation and economic growth. Joshua Shapiro, of MFR Inc. has an interesting theory, “Our own view is that unusually warm weather has played a role in boosting activity…data will cool off as weather patterns (presumably) normalize. However, until this is borne out in the data, the Fed and markets will remain concerned about the effect that an upside growth surprise could have on inflation pressures.” The weather should bear watching.

It is our own view that the economy can still grow without impacting inflation. Energy costs – while still high – seem to have abated some. Wages have grown – except at the lower end of the income scale. That has a way of keeping the lid on the wage-price spiral.

We have one great inflation fear in the mid-term; corn prices. With all the talk of alternate fuel and ethanol, corn futures have nearly doubled. That will impact not just corn flakes, but pop/soda, beef, and pig, just about anything we eat.

Commentary: Let’s eat food and burn oil.

Steve Boxmeyer [612] 799 – 6858
steveb@LendWithIntegrity.com