Rally before data as recession worries mount

LONDON: US Treasuries rallied in Europe on Thursday, with investors expecting a raft of data later in the day to be consistent with their fears that the world's largest economy risks entering a new recession.

Doubts that euro zone policymakers are doing enough to tackle the debt crisis are also keeping safe-haven assets well bid and some traders said T-note yields could soon re-test all-time lows seen at the time of the Lehman collapse of 2.04 percent.

The US data calendar offers up high profile economic indicators later in the session when inflation, employment and housing data are released along with forward-looking economic sentiment survey results.

Benchmark 10-year T-note yields were last down 5.6 basis points at 2.11 percent, five-year yields fell 4.6 bps to 0.8648 percent.

"Markets are worried about a jump in jobless claims and a drop in the Philly Fed (business index) and everybody is trying to assess how large a damage the economy (will face), will it be a second recession or just a slowdown," said Philip Marey, strategist at Rabobank.

"We also have this pledge by the Fed to keep interest rates low... so I wouldn't be surprised to get through 2.05 percent sooner or later when we get some bad data."

Jobless claims are expected to rise to 400,000 from 395,000 according to Reuters polls, while the Philly Fed index is expected to rise to 3.7 from 3.2.

Data on Wednesday that showed that US core producer prices rose at their fastest pace in six months in July also added to concern inflation may be accelerating.

Further confirmation of rising prices would make it more difficult for the Fed to pursue further stimulus.

Lloyds strategists, who expect inflation at 3.1 percent versus Reuters consensus of 3.3 percent recommended in a morning note going into the release long Treasuries and short UK Gilts, which pared some gains after a 5-year auction

EURO WOES

US bonds could pare some gains in case of a positive surprise from the data, but losses are expected to be brief and capped by concerns over the euro zone crisis.

Markets looking for more positive steps to address the region's woes were left disappointed by the outcome of a Franco-German summit which instead focused on longer-term issues.

"The realisation is settling into the market that things are not good and it's going o stay that way. I expect ten-year yields to be trading below 2 percent very soon," one trader said.

He also said that given the recent flight to safety brought 2-year yields to very low levels -- they traded flat on Thursday at 0.19 percent -- investors will move up the yield curve in search for more meaningful returns.

"(Two-years) are going to be stuck here for a long time but 2s/10s are going to go through the lows as people are going for yield," the trader said.

The 2/10-year yield spread was last 5 bps narrower on the day at 192 bps, having tightened by more than 60 bps since mid-July.

Copyright Reuters, 2011