Weak Manufacturing Report Juices Treasuries

Short-term yields hit their lowest levels in 11 weeks as odds of an August rate hike fall.
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In a holiday-shortened session, the Treasury market rallied in response to a weaker-than-expected report on the manufacturing sector. Yields on short-maturity issues dropped to their lowest levels since mid-April as investors discounted longer odds that the Fed will hike interest rates next month.

Volume was very light, however. Trading desks were thinly staffed as many bond market pros stretched the weekend into the July 4 holiday tomorrow. According to tracker

GovPX

, $8.6 billion of Treasuries changed hands by noon, 27% less than average for a Monday over the past month. The trading session ended at 1 p.m. EDT in accordance with a recommendation by the

Bond Market Association

.

The benchmark 10-year Treasury note ended up 8/32 at 103 21/32, dropping its yield 3.6 basis points to 5.991%, the lowest since June 18. The 30-year bond rose 10/32 to 105 7/32, lowering its yield 2.1 basis points to 5.877%.

Shorter-maturity issues, which are most directly influenced by the

fed funds rate, fared even better, as people decided that a rate hike by the Fed on Aug. 22, its next meeting, appears somewhat less likely. The two-year Treasury note rallied 3/32 to 100 3/32, dropping its yield 5.6 basis points to 6.319%, the lowest since April 14. And the five-year note gained 8/32 to 102 18/32, slicing its yield 6 basis points to 6.126%, also the lowest since April 14.

At the

Chicago Board of Trade

, the Spetember

Treasury futures contract gained 11/32 to 97 22/32.

The catalyst for the rally was the 10 a.m. release of the

Purchasing Managers' Index

. The key manufacturing-sector indicator fell for the fourth month in a row in June to 51.8, from 53.2 in May. The June reading was the lowest since January 1999, suggesting that the Fed's campaign to slow economic growth with higher interest rates is working. It was also lower than expected. Economists polled by

Reuters

had forecast a reading of 53.5, on average.

Not only was the headline number weak, so were many key components of the report. Sub-indices tracking production, new orders, employment and prices all fell, with the last two falling sharply. Considering that oil prices rose in May and June, the decline in the price index was especially good news,

ClearView Economics

chief economist Ken Mayland observed in a research note.

"A lot more data will come out between now and Aug. 22," Mayland wrote. "These two early pieces of evidence, though,

the PMI and the

construction spending

report, also released today help to make the case, and will increase the speculation, that the Fed's work may be done for this monetary policy tightening episode."

At the CBOT, traders of

fed funds futures downgraded to 56% from 80% the odds of an August hike in the target fed funds rate to 6.75% from 6.5%.

"I think this sets the tone for the week," said Claude Persico, market economist at

Dresdner Kleinwort Benson

. "The economy seems to be downshifting a bit." With no major economic data slated for either Wednesday or Thursday, "we should drift higher as the week goes on," Persico said.

Till Friday, anyway, when the release of the June

employment report

provides the next major indication of whether expectations of slower growth and still-low inflation are well-founded.

Economic Indicators

In other economic news, the pace of

construction spending

gained 0.1% in May, dashing the average forecast that it would rise 0.2%. But the year-on-year pace rose from 5.3% to 7.3%.

Also, the

Purchasing Managers' Non-Manufacturing Index

(

definition |

source

), released unexpectedly (it had been scheduled for Wednesday) rose to 64.0 in June from 61.5 in May.

Currency and Commodities

The dollar fell against the yen and gained against the euro. It lately was worth 105.62 yen, down from 106. The euro was worth $0.9497, down from $0.9523. For more on currencies, please take a look at

TSC's

Currencies column.

The

Bridge Commodity Research Bureau Index

fell to 222.03 from 223.93.

The

New York Mercantile Exchange

/

Comex

, where oil and gold futures are listed, was closed.