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Chicago PMI's Got Bonds Down Ahead of Fed Announcement

With volume light in anticipation of the Fed's expected rate hike, manufacturing strength has the market running scared.

The perpetually freaked-out bond market cursed this morning's

Chicago Purchasing Managers' Index

, which revealed broad-based strength in the Midwest manufacturing region. Treasuries are selling off, especially long-dated maturities. The market expects the

Federal Reserve

to announce its first interest-rate hike in more than two years this afternoon, but the selloff indicates nervousness about important economic reports coming later this week.

"The market's been selling off pretty rapidly after the 10:00 number," said a trader at a primary dealer, referring to the Chicago number. "The prices paid component was much, much worse than anybody had expected. I don't think people think the Fed is going to move 50 basis points today because of this -- the Fed is not going to move on today's number. But people are more willing to be short in the market again."

Of late, the 30-year Treasury bond was down 12/32 to trade at 88 16/32. The yield rose 3 basis points to 6.09%. Today's session is marked by extremely light volume, as the market's mostly preoccupied with waiting for the expected announcement of a 25-basis-point rate hike in the fed funds target rate to 5% from 4.75% at about 2:10 p.m. EDT, and the statement that accompanies it. The consensus is that the Fed will retain its bias toward raising rates again, rather than shifting back into neutral.

Tracker

GovPX

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reported volume down 49% when compared to other Wednesdays this month, as just $11 billion of securities traded hands by 10 a.m.

The Chicago Purchasing Managers' Index, a survey of manufacturing sentiment, rose to 60 in June, up from May's 57.9 reading. Several components of the index rose from last month, indicating that the sector continues to regain strength. The prices paid series rose to 57.2, its highest level in 18 months. While private-sector data does not always predict what government statistics will report later, the Fed's going to be watching to see if higher producer costs result in higher prices. The new orders component rose to 65.5 in June, after falling to 59.6 in May.

Earlier this year, Fed officials seemed to indicate that strong growth alone would not cause a change in monetary policy. But in the last two months, judging by their public comments, they've reversed course, and have been attuned to strength in demand and the potential inflation that could result.

Today's report doesn't help the bond market, especially considering the national version of the Chicago release is due out tomorrow, followed by Friday's release of the June

employment report

. The Chicago report doesn't contain a clear-cut inflation component (higher producer prices could be offset by productivity gains, which this report doesn't really measure), but it's got the market thinking about the policy implications of strong readings from the next two economic reports.

To be sure, the light volume is exaggerating today's move. But one trader was surprised at the swiftness of the selling, especially in the five-year and 10-year maturities. The 10-year note was lately down 12/32 to yield 5.98%, and the five-year lost 8/32 to 5.87%. Sources reported that the selling of those maturities came from overseas -- most foreign bond markets use a 10-year maturity as the benchmark.

"If anything, it suggests the market is on pins and needles to a certain extent here, and the conditions are more than likely thin," said Tom Ruff, vice president in proprietary trading at

Daiwa Securities America

.