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Treasurys Slip on Economic Data, Stock Gains

Treasury debt prices dipped Thursday, as reports of a stronger-than-expected U.S. service sector and job market reduced expectations for a deep cut in official interest rates.

Major U.S. retailers, led by discounters Wal-Mart Stores and Target, contributed to the evidence of a still-growing U.S. economy, reporting better-than-expected August sales as consumers shopped for back-to-school items despite higher gas prices and the U.S. housing meltdown.

Analysts said stock market gains put some pressure on bond prices, though persistent signs of trouble in the mortgage market and remaining concerns about the availability of credit kept a floor under U.S. government debt prices.

In afternoon trading, the benchmark 10-year note was down 8/32 in price for a yield of 4.49 percent, compared with 4.47 percent late Wednesday. Bond yields and prices move inversely.

"The economic data were a bit better, stocks are trying to gain some upside momentum and the Treasury market may be overbought," said William Sullivan, chief economist at JVB Financial Group.

"The feeling is that the Fed does not want to operate on an inter-meeting basis, so if you only get a 25-basis-point rate cut in September, you might have to wait until the end of October to get the next 25 basis points."

The Federal Reserve is expected to cut interest rates at its Sept. 18 meeting. After Thursday's jobless claims, rate futures indicated traders are less certain the Fed will cut by 50 basis points.

Still, Treasury market losses were limited, given higher levels of foreclosures and deliquencies in the U.S. mortgage market in the second quarter, developments that could weigh on future economic growth.

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Also, investors were hardly ready to abandon the relative safety of U.S. government securities given continued stresses in the credit markets.

Partly in response to those difficulties, the Fed added a total of $31.25 billion in temporary reserves to the banking system via system repurchase agreements Thursday. Earlier, the European Central Bank added 42.245 billion euros ($57.4 billion) in temporary overnight funds to money markets to ease tensions in the euro interbank lending market.

"The liquidity injections today were quite sizable and the largest since the Fed injected $38 billion on Aug. 10," said Stone and McCarthy Research Associates economist Kenneth Kim.

London interbank lending rates for the euro fell sharply on Thursday after the European Central Bank injected liquidity, but three-month lending rates (LIBOR) remained elevated, with sterling rates at their highest level in almost nine years.

Kim and other analysts said the injections were partly aimed at "calming fears of a credit crunch that are still lingering as evidenced by the elevated LIBOR rate."

"The Fed is really focusing on two issues: the working of the credit markets and the economy," said Sullivan. "The economy seems to be holding its own."

But he added, "when you look at the credit market situation, there are huge stresses" which could lead to a rate cut. The financial market upheavals are important for the Fed to watch because "if credit market stresses are sustained, eventually the economy will suffer."

Bond investors' next focus is on potentially market-moving August non-farm payrolls job numbers due Friday.

Signs of a weakening labor market could tilt the Fed toward cutting its benchmark federal funds rate by a more aggressive half percentage point at its September 18 policy meeting.

Evidence of labor market resilience could restrain the Fed's hand, making the central bank more likely to cut rates by just a quarter percentage point.

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