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Bonds Up as Factories Slow, Banks Hit by Credit

Long-dated U.S. government bonds rose on Monday as the outlook for manufacturing dimmed and three top investment banks said earnings came under pressure from the global credit crisis.

The Institute for Supply Management said U.S. manufacturing expanded in September at its slowest pace since March, raising concerns that the sector will not be able to shore up the economy against the housing slump.

UBS, Credit Suisse and Citigroup acknowledged that the credit squeeze caused by the U.S. mortgage mess took a toll on earnings, making safe-haven U.S. government debt attractive as some investors sought protection from the widening fallout.

"We had good inflation data last week followed up with weaker numbers this morning from the ISM side. That combination should lead to a more calming effect in the long end of the bond market," said Bob Millikan, director of fixed-income at BB&T Asset Management in Raleigh, N.C.

"More trouble at the investment banks is just going to help cause the economy to be a little softer for longer," he said.

"We're not going to pull out of this in a month and say there was no impact from housing and subprime."

Bond yields move inversely to prices.

Benchmark 10-year notes rose 10/32 in price, pushing yields down 4 basis points to 4.55 percent.

Five-year notes rose 3/32 to yield 4.23 percent.

The 30-year long bond surged 26/32 to yield 4.79 percent.

Short-dated Treasurys, which benefit most from Fed rate cuts, struggled: Two-year notes slipped 2/32 to yield 4.02 percent.

End of the Steady March

Two-year notes have marched steadily higher since the Federal Reserve's aggressive September interest rate cut as the economic numbers pointed to continued weakness in housing and financial markets revealed only tentative signs of recovery.

Many analysts believe that as the ever-widening impact of the tightening of credit markets becomes apparent, investors will tend to favor the safety of fixed returns earned on Treasurys.

Others say the bond market may have gone too far without a sharper deterioration in the economic data. Though the ISM index slipped to 52 in September, it remains above above the 50 level that separates expansion from contraction.

Bond traders also noted that stocks rallied on Monday, pushing the Dow Jones industrial average to a record high as equities investors bet that Wall Street may have seen the worse of the credit squeeze.

As long as stocks hold up and the economy continues to grow, although at a slower pace, investors may trim the holdings of shorter-dated notes they had acquired on the view that the Fed would continue to cut.

"In general, I think people are getting a sense that the numbers are not bad enough for the Fed to cut at the next meeting," said Rick Klingman, managing director of U.S. Treasury trading at BNP Paribas in New York.

"They are watching stocks go up, they are watching the data come in soft but not horrible and they are saying, 'The Fed just went 50 (basis points), maybe they will just take a pause at this meeting.'"

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