Fri Jul 30, 2004
By Wayne Cole

NEW YORK (Reuters) - Treasury prices rallied on Friday, recouping some of the week's looses, after data on regional manufacturing proved mixed when the market had been braced for outright strength.

The benchmark 10-year note (US10YT=RR: Quote, Profile, Research) rose 18/32 in price, lowering yields to 4.51 percent from 4.58 percent. That is down from a 4.64 percent peak early in a tough week, but still well above its recent 4.35 percent low.

The Chicago purchasing management index of business activity bounced to 64.7 in July after a dip to 56.4 in June, handily beating forecasts of a rise to 59.0. However, the employment index surprised many by slumping to a one-year low of 45.6 and prices paid pulled back from recent highs.

Bonds had firmed early as data showed economic growth slowed more than expected in the second quarter, though the Chicago report added to evidence that growth may have picked up at the start of this quarter.

The data reinforced analyst expectations that the Federal Reserve would keep tightening at a gradual pace, though that still means rates could hit 2.25 percent by Christmas.

"So far, the July statistics have been reasonably healthy. Next week we get the ISM and payrolls, both of which will give you a sense of where the third quarter is starting. Our sense is that the third quarter started on a good note," said Ram Bhagavatula, chief economist at RBS Financial Markets.

"It keeps the Fed on its measured pace of tightening... a quarter point at every meeting," he added. The Fed has four policy meetings left this year.

Yields on the two-year note (US2YT=RR: Quote, Profile, Research) dropped to 2.70 percent from 2.77 percent late Thursday. The five-year note (US5YT=RR: Quote, Profile, Research) rose 10/32 in price, taking its yield to 3.71 percent from 3.79 percent.

At the long end, 30-year bonds (US30YT=RR: Quote, Profile, Research) gained 23/32, lowering yields to 5.25 percent from 5.30 percent.

Terror concerns were never far away as a blast rocked the U.S. embassy in Tashkent, encouraging a safe-haven bid for bonds ahead of the weekend.

A fresh rise in oil prices offered some support to bonds. While higher energy costs can feed inflation, they are also seen as a tax on consumption and a drag on both economic growth and equity prices. As such they could give the Fed pause in its plans to steadily raise interest rates.

Treasury prices had firmed early after data showed the U.S. economy slowed more than expected last quarter while one closely-watched measure of underlying inflation turned lower.
Gross domestic product rose at an annualized 3.0 percent rate in the second quarter, though growth in the previous quarter was revised up to 4.5 percent.

The surprise came in consumption, which rose only 1.0 percent, its lowest reading in three years. Much of that weakness was due to high energy prices swallowing up more of each dollar spent.

Still, the Fed's favored measure of inflation, the core personal consumption expenditures price index, pulled back to 1.8 percent after being revised up sharply to 2.1 percent in the first quarter.

"The real story here is the (slower) growth of consumption in the quarter," said Kevin Logan, an economist at Dresdner Kleinwort Wasserstein.

"The core consumption index slowed down and that should alleviate some concerns about inflation. What we see in this data is the Fed will stick to their measured pace or maybe even slow down a bit," he added.

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