With recession confirmed, focus on jobs

By John Parry

NEW YORK (Reuters) - A rally in U.S. Treasuries after the weakest manufacturing report since 1982, which pushed yields to five-decade lows, leaves the market increasingly exposed to the risk of a sell-off if employment data to be released on Friday proves less than dire.

But with no significant economic data due out before Friday, the stock market will continue to be the biggest catalyst driving Treasuries in the interim, with any further stock sell-offs likely to push government securities prices higher.

The National Bureau of Economic Research on Monday said the U.S. economy has been languishing in recession since December 2007. That leaves bond investors pondering just how ugly Friday's release of the government's monthly employment report might be and how much higher Treasury prices can go in anticipation.

The employment report is expected to show the U.S. shed 320,000 non-farm payrolls jobs in November, according to economists' median forecast, accelerating the labor market decline from 240,000 losses in October.

"If we got 400,000 then that could push Treasuries to rally even further," said Jay Mueller, senior portfolio manager with Wells Capital Management in Milwaukee, Wisconsin.

"We are factoring in a severe recession that lasts at least another couple of quarters," Mueller said. "If I had confidence the recession would be over by the middle of next summer, I would want to be a seller (of Treasuries) at these levels," he added.

Yet there is some risk that despite the huge additions of government cash aimed at refloating the economy, an environment of falling prices, or deflation, may yet take hold, in which case Treasuries "are the only place you want to be," Mueller cautions.

On Monday, the benchmark 10-year Treasury note's yield, which moves inversely to its price, fell to about 2.65 percent, the lowest in five decades.

Federal Reserve Chairman Ben Bernanke's signal that the Fed might start buying longer maturity Treasuries added fuel to the government bond market's gains. If the rally persists, the Treasury market may be forewarning the United States will experience a "lost decade" of economic growth during which prices fall, as in 1990s Japan, analysts warn.

Yet fixed-income investors are of two minds. There is a fierce bond market debate between those who believe inflation has been quashed as the U.S. economy slumps and those concerned that the government's massive cash injections into the financial system will ultimately ignite a major inflationary fire.

"Despite the behavior of the Treasury market, there are still a lot of people anticipating inflation," said Lawrence Glazer, managing partner of Mayflower Advisors in Boston.

"Some people are still focused on the Fed printing money and inflation somewhere down the line," he added.

For now, most investors appear unfazed by this danger. When stocks sell off steeply on fears about the banking system and the beleaguered economy, the kneejerk reaction is still to shelter in comparatively safe Treasuries and push government securities' prices yet higher.

(Editing by Leslie Adler)