TREASURIES-Bonds retreat on pick-up in service sector activity

Ellen Freilich
Tuesday, 5 Nov 2013 | 4:37 PM ET

* U.S. service sector growth, expected to slow, instead quickens Nonfarm payrolls on Friday could be hard to parse because of shutdown

* U.S. Treasury quarterly refunding announcement due Wednesday

NEW YORK, Nov 5 (Reuters) - Prices for U.S. Treasuries fell on Tuesday as stronger-than-expected U.S. service sector data reinforced the view that the world's biggest economy may have weathered last month's partial government shutdown better than feared. U.S. service sector business activity picked up in October, with the Institute for Supply Management's services index up to 55.4 last month despite expectations by economists for a dip to 54. A reading above 50 indicates expansion. Bond prices were already lower when the ISM report was released, responding to what Columbia Management strategist Zach Pandl characterized as "a broad-based firming in economic data, in the last week, both in the U.S. and globally." But bonds' early losses widened after the ISM report. "We've seen business or purchasing managers surveys improve for a broad set of countries, notably for some emerging Asian and Eastern Europe markets that had been lagging in the recent recovery," Pandl said. Last month European factory production looked more robust and factories in China also boosted production. In the U.S., October readings on the Institute for Supply Management's manufacturing and non-manufacturing indexes were also "consistent with healthy growth," Pandl said. One caveat to the "healthy growth" description has been businesses' weak capital spending. But Pandl said if the "statistically reliable" business survey data keep improving, stronger capital spending "probably is not far behind." What hurt Treasuries on Tuesday was that the stronger ISM indexes "point to some upside risk in the October non-farm payrolls data due Friday," Pandl said. In a recent Reuters poll, economists estimated U.S. non-farm payrolls added just 125,000 jobs in October. The employment index in the October ISM non-manufacturing index rose to 56.2 in October, bringing it closer to the six-month peak hit in August. Economists had worried the government shutdown in the first part of October would hurt growth. The U.S. service sector readings came after data earlier in the day showed Britain's services sector expanded at its fastest rate since May 1997 last month. The U.S. Federal Reserve is watching for signs of a sustainable, stronger economy, with an eye to paring back its $85-billion-per-month bond-buying program. The timing of such a potential cutback has come to preoccupy the Treasuries market. Despite expectations for a September taper, the central bank has instead stayed its course, although it did acquire a more hawkish tinge at its late-October policy meeting. Fed Chairman Ben Bernanke has repeatedly said that the Fed's decision will depend on data showing the health of the world's biggest economy. "It's just to taper or not to taper," said Wilmer Stith, portfolio manager of the Wilmington Broad Market Bond Fund. "At the end of each day, that's going to be the primary focus." Fed speakers have emphasized that message, with three separate Fed officials on Monday suggesting the Fed should only trim asset purchases on clearer signs of improvement in the economy and should act slowly when it does so. Richmond Fed President Jeffrey Lacker said, however, that the U.S. government shutdown and other budget battles should not keep the Fed from starting to drain some of the monetary stimulus soon. The most significant upcoming data point for potential policy changes will be Friday's nonfarm payrolls report for October. But that report itself will be problematic, considering that a congressional impasse shut most of the federal government for the first half of last month. A weak number, noted Ian Lyngen, senior government bond strategist at CRT Capital Group, "will simply be dismissed as the transitory influence of the government shutdown and civilian furloughs; but on the other hand, if the release comes in above consensus, it will be read as that much stronger given the weight of the shutdown." Fed policymakers want to see the unemployment rate dropping closer to 6.5 percent from the current 7.2 percent, but economists in a Reuters survey expect that rate to have edged up in October to 7.3 percent. Prices for U.S. benchmark 10-year Treasury notes fell 16/32 in price on Tuesday while its yield rose to 2.66 percent from 2.61 percent late on Monday. The U.S. 30-year bond fell 1-03/32 in price as its yield rose to 3.76 percent from 3.70 percent late Monday. The U.S. Treasury on Wednesday will issue its quarterly refunding announcement, which will set out upcoming funding needs and perhaps discuss the Treasury's plans to issue floating rate notes in 2014. As part of its ongoing stimulus program, the Fed on Tuesday bought $1.565 billion of Treasuries maturing between February 2036 and February 2043.