Treasury security prices fell yesterday when the surprisingly strong Purchasing Managers' report for May suggested the manufacturing sector is well on its way to recovery.
Traders said a big increase in commodity prices added to the Treasury market's losses yesterday.
Late in the afternoon, the 30-year bond was 5/8 point lower and yielded 7.88%.
The purchasing managers' "report came out and it was fairly strong, and the jobs portion was fairly strong as well," said James Kenney, head of Treasury trading at Prudential Securities. "That coupled with the big jump in the [Commodity Research Bureau index] put the market under a fair amount of pressure."
The purchasing managers' index jumped to 56.3% in May from 51.3% in April, when the consensus forecast was for only a 52.0% reading. And the report's employment component surged to 49.1%, its highest reading in three years, from 43.9% in April.
Meanwhile, the Commodity Research Bureau's index of commodity prices rose 2.51 points to 210.48.
The gains in commodity prices were widespread. Analysts said reports of dry weather in the Midwest pushed grain prices higher, but said the increases in other commodity prices may just show traders were rolling forward into the new front-month futures contracts.
The jump in the purchasing managers' index was harder to explain away.
Daniel Seto, an economist at Nikko Securities, said the improvement was broad-based, with all of the index's components showing gains.
"But the most striking element is that both production and new orders were above 60% and clearly showing signs of expansion," Mr. Seto said.
For the bond market, the most troublesome statistic was the improvement in the May employment component, since it hinted that this week's key statistic, the May non-farm payrolls number to be released Friday, would show a healthy gain.
The gain in the employment index "certainly suggests manufacturing employment will show a good increase," said Martin Mauro, a senior economist at Merrill Lynch Capital Markets.
Mr. Mauro is expecting a 25,000 gain in May manufacturing payrolls and a 145,000 rise in total payrolls. Economists surveyed by The Bond Buyer on average expect a 95,000 increase in payrolls.
Mr. Seto said the rise in the purchasing managers' employment component did not tell the market much that was new, since most economists already expected an increase in May manufacturing payrolls.
The purchasing managers' report overshadowed yesterday's other numbers, which were in line with expectations, and in any case looked like old news to the market.
April personal income grew only 0.1% and spending was up 0.3%, while April construction spending declined 0.3%.
Taken separately, the income and spending report indicated a risk the recovery will slow down, but they were April numbers, Mr. Mauro said. "Based on what we're seeing for May in the [National Association of Purchasing Management] report, it looks as if the economy will show better growth in May."
Traders said retail investors were mostly absent yesterday and the selling that drove prices lower was done by dealers.
"Retail investors are still holding on" to their positions, a note trader said.
During the afternoon, the market came off its lows, but traders said short-covering by Street firms was responsible for the bounce-back.
Despite yesterday's dramatic price swings, participants said the market is still stuck in a trading range and will not be able to set a new direction until it gets some decisive information on the economy.
If May nonfarm payrolls rise more than expected, that would confirm the improvement in yesterday's purchasing managers' report and convince the market the economy is recovering, a bond salesman said.
But he said that realization would mostly affect short-term Treasury prices.
"If we can validate that the Fed is right and the economy is doing better, there's no reason we can't reprice the front end and flatten the curve," with the two-year yield rising to 5.50% from the current 5.25%, the salesman said.
At yesterday's auction of $23.3 billion of bills, the three-month bills were sold at an average rate of 3.75% and the six-months were sold at 3.90%. A bill trader said the auction went "all right," given the sour tone in the market.
This morning's economic statistics, the April index of leading indicators and April new home sales, should not cause much of a stir, traders said.
The consensus forecast calls for a 0.2% gain in the leading indicators and a 6.4% rise in new home sales.
"The only thing that matters is Friday," a bond trader said.
The September bond futures contract closed 23/32 lower at 99, and the June contract was off 23/32 at 100-3/32.
In the cash market, the 30-year 8% bond was 19/32 lower, at 101-7/32-101-11/32, to yield 7.88%.
The 7-1/2% 10-year note fell 13/32, to 100-25/32-100-29/32, to yield 7.36%.
The three-year 5-7/8% note was down 7/32, at 100-5/32-100-7/32, to yield 5.79%.
Rates on Treasury bills were higher, with the three-month bill three basis points higher at 3.75%, the six-month bill up three basis points at 3.89%, and the year bill was seven basis points higher at 4.13%.
Monday Week Week
3-Month Bill 3.81 3.79 3.70
6-Month Bill 4.00 3.97 3.86
1-Year Bill 4.30 4.25 4.24
2-Year Note 52.5 5.32 5.29
3-Year Note 5.79 5.86 5.81
4-Year Note 6.65 6.74 6.78
5-Year Note 6.66 6.77 6.80
7-Year Note 7.01 7.09 7.17
10-Year Note 7.36 7.43 7.54
15-Year Bond 7.66 7.70 7.78
30-Year Bond 7.88 7.91 8.01