Tuesday, July 31, 2007

Treasurys Gain on Inflation Data


Treasury prices came off earlier lows Tuesday, keeping yields in a tight range, after the Commerce Department reported benign increases in core consumer inflation and employment costs in June.

The 10-year note was off 2/32, or 63 cents per $1,000 invested, at 97-18/32, while its yield stood at 4.816%. The 30-year long bond was 1/32 lower at 96-26/32 with a yield of 4.957%. The two-year note fell 3/32 at 99-31/32 with a yield of 4.642%. Prices and yields move in opposite directions.

Although the day's economic reports were supportive of Treasurys, a rebound in the stock market put the government-bond market under mild pressure.

Treasury prices opened lower, but losses lightened after the Commerce Department said core consumer inflation increased 0.1% for the fourth consecutive month in June, pushing the yearly gain in core inflation down to the lowest level in three years. Overall inflation also increased 0.1% in June.

Separately, the Labor Department said U.S. employment costs increased 0.9% in the second quarter, in line with expectations.

Both numbers suggest inflation pressures are moderating, a positive development for inflation-sensitive fixed-income assets. In addition, soft inflation trends might eventually help open the door for the Federal Reserve to cut interest rates.

"As recently as February, [core consumer inflation] was up 2.5% year over year, so the speed of the decline has been impressive," said Ian Shepherdson, chief U.S. economist at High Frequency Economics. "Still, the Fed is yet to be convinced it is sustainable."

"With productivity growth slowing -- though not collapsing -- the unit labor cost picture is not quite so good, but there is nothing here to suggest inflationary pressure is building," Mr. Shepherdson said.

In addition, the Chicago purchasing managers reported that business activity in the Chicago region worsened in July. Signs of economic weakness support the fixed-income market.

The group's index dropped to 53.4% in July from 60.2% in June. The number was below economists' expectations. Readings of more than 50% indicate that more companies were expanding than contracting.

In another report pointing to possible economic softness, the Commerce Department said spending on U.S. construction projects fell 0.3% in June to an annual rate of $1.18 trillion, the Commerce Department said Tuesday. The result marked the first drop in construction outlays since January. Separately, the Conference Board reported that consumer confidence reached its most boisterous level since Sept. 11, 2001.

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