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Treasurys rally; 10-year yields orbit key 2.5% mark

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U.S. Treasurys prices gained on Thursday and benchmark 10-year note yields dropped below 2.50 percent for the first time since last October after a weak manufacturing indicator overcame other data releases that showed solid U.S. economic strength.

The rally was also seen as due to a record number of short positions, where investors bet on yield increases, as these investors have been forced to cover their bearish bets each time bonds rally. U.S. industrial output fell at its fastest rate in more than 1-1/2 years in April as factory production slumped, tempering hopes for a big jump in economic growth after a winter slowdown.

Data earlier on Thursday was more bullish on the economy, showing that fewer Americans filed for unemployment benefits in the last week, consumer prices posted their largest increase in 10 months in April and a gauge of manufacturing in New York state accelerated to its fastest pace in nearly four years.

Bearish bets on five-year and ten-year Treasurys futures have also increased in recent weeks.

Read MoreStocks in the red as bonds catch fire

Benchmark 10-year Treasury notes were last up 13/32 in price to yield 2.50 percent. Ten-year note yields touched a session low of 2.47 percent earlier, dipping below the psychologically-important level of 2.50 percent for the first time since October.

Thirty-year bonds were last up 23/32 in price to yield 3.34 percent.

Treasurys have rallied even as many investors see yields as likely to rise as the economy gains momentum, with many speculating that the Federal Reserve is likely to begin raising interest rates next year.

Some of the gains are due to the expectation that central banks globally will continue to provide loose monetary conditions, with the European Central Bank expected to cut interest rates next month.

But a record number of speculators betting on bond yield increases is also increasingly seen as behind the bond rally, throwing the market off balance and sending yields lower regardless of what the U.S. economic data shows.

Read MoreTepper on the market: 'I think it's nervous time'

"The short positioning in the street has been really quite severe," said Aaron Kohli, an interest rate strategist at BNP Paribas in New York. "Too many people got short early and now there is no one left to follow them into the trade and they are covering themselves."

Data last Friday showed that speculators' net bearish bets in Eurodollar futures rose to a record high in the previous week following an unexpectedly strong reading on U.S. payrolls in April, according to Commodity Futures Trading Commission.

—By Reuters

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