US Treasury debt prices retreated on Monday after a second monthly gain in a key manufacturing index suggested the industrial sector was on the mend. The scenario suggested Federal Reserve policy-makers could keep raising interest rates without worrying about stifling economic growth, a bad omen for bonds.
"It seems likely to us that the Fed will ratchet up rates more than currently expected, most likely at least through mid-2006," said Charles Lieberman, chief investment officer at Advisors Capital Management.
The news was particularly painful for bond investors, given that many of the market's strides in recent months had been due to suspicion that US factories might be on the verge of a slowdown.
Exacerbating July's steep upward trajectory in benchmark yields, the solid survey results from the Institute for Supply Management were enough to drag 10-year notes 8/32 lower for a yield of 4.32 percent, its highest closing level since mid-April.
That was up from 4.28 percent late last week and nearly 40 basis points above its levels just one month ago.
Oil prices near record highs threatened the productivity of energy-intensive factories, analysts noted, but not enough to rescue the bond market from its troughs of the day.
Crude oil futures peaked at $62.30 per barrel on Monday, an all-time high. Bond bulls have long been hoping that spiking energy costs would eventually crimp both businesses and consumers, but any adverse effects have been muted thus far.
The 30-year bond was down 20/32 and yielding 4.51 percent, compared with 4.47 percent on Friday.
At the short end of the yield curve, two-year notes dipped 1/32 for a yield of 4.04 percent, its highest closing level in four years. Five-year notes were off 4/32 and yielding 4.16 percent from 4.13 percent.
GLOBAL FACTORY BOUNCE? US factories put in another strong month, according to the ISM data, quashing speculation that the industrial sector might be at the cusp of a period of contraction.
The ISM index rose to 56.6 in July, up from 53.8 in June and above Wall Street's estimates of a more subdued gain to 54.5.
Another factor for Treasury investors, the employment index crept back above the 50-mark that separates growth from contraction, boding well for Friday's payrolls report and thus ill for bonds.
Growth in manufacturing was not limited to the United States either, with surveys in Europe and Japan also showing expansion.
"This will reinforce the FOMC's view that the economy will continue to grow moderately," said Steven Wood, chief economist at Insight Economics. "It also suggests that there is more Fed tightening to come."
Economic strength had so overwhelmed the bond market that investors had little positive reaction to what appears to be a likely reduction in the supply of government bonds. The Treasury Department said on Monday it expects to borrow a much smaller-than-forecast $59 billion in net debt in the July-to-September quarter because of buoyant tax receipts.
The Department had said in May it expected to borrow $103 billion in the current period.