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Strong Manufacturing Report Renews Bond Rout

Making matters worse, a dovish Fed head is plastering the wires with hawkish remarks.

A stronger-than-expected report on the state of the manufacturing sector and bearish comments by a

Fed

official have walloped the Treasury market this morning, pushing the long bond's yield back up toward its highs of mid-May, and jacking shorter-term note yields to their highest levels in nearly a year or more.

In the wake of the 10 a.m. EDT release of the

Purchasing Managers Index

for May and

New York Fed

President

William McDonough's

remark that it's unclear that the big jump in the April

Consumer Price Index

was a one-time event, the benchmark 30-year Treasury was down 1 2/32 at 90 25/32, lifting its yield 8 basis points to 5.91%.

The long bond closed at its highest yield for the year, 5.93% on May 14, the day of the April CPI release. (The consumer inflation indicator experienced its sharpest rise since October 1990.) But the bond is faring much better than shorter-term notes, whose yields are more closely tied to the short-term interest rate set by the Fed. With the odds improving that the Fed will hike the fed funds rate at its next meeting on June 29-30, note yields are spiking. The two-year note, for example, was off 7/32, lifting its yield 12 basis points to 5.52%, the highest since June 25, 1998. As a result, the difference in yield between the long bond and the two-year note, a popular measure of the slope of the yield curve, has shrunk to 39 basis points, a low for the year and the lowest since Sept. 4.

The Purchasing Managers Index, a key manufacturing indicator that signifies growth when above 50 and contraction when below 50, rose to 55.2 in May from 52.8 in April. It was the strongest reading since October 1997. Economists surveyed by

Reuters

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had forecast a rise to 53.4.

But it wasn't just the overall index that rattled the bond market. An array of sub-indices accompany the PMI, and two in particular -- the employment index, which is part of the PMI, and the prices paid index, which is not -- were disconcertingly strong. "There was no aspect of the report that the market could take solace in,"

Miller Tabak Hirsch

chief bond market strategist Tony Crescenzi said.

The employment index rose to 53.5 from 49.5 for its first positive reading since May 1998. And the prices paid index rose to 52.2 from 49.9 for its first positive reading since December 1997.

The employment index reading has bond traders scared that the May

employment report

, scheduled for release this Friday, will detect growth in manufacturing payrolls for only the third time in the last 15 months, once of which was a strike-related fluke. Manufacturing job growth also tends to spur potentially inflationary earnings growth, since manufacturing jobs typically pay more than average.

As for the prices paid index, "it stands out more considering what

McDonough said," Crescenzi said.

The New York Fed head's comment to the

Georgia Bankers Association

in New York this morning is all the more resonant, Crescenzi said, because compared to his colleagues on the Fed's monetary policy committee he is considered dovish, or tolerant of inflation risk.

Because of this morning's events, traders will tune in especially closely to a speech Fed Vice Chairman

Alice Rivlin

is slated to give at 12:30 p.m. EDT in Montreal. Rivlin is the only Fed policymaker considered more dovish than McDonough, and compared to her Fed colleagues she tends to speak more plainly.