U.S. Treasury prices fell Monday as data showing a slump in U.S. manufacturing was not quite as grim as market expectations, tempering the safe-haven allure of government bonds.
Bond prices have been trading at expensive levels and by some accounts were due a pullback, coming off their biggest weekly rally since October.
Philadelphia Federal Reserve Bank President Charles Plosser helped that process along when he raised concerns that inflation expectations were creeping up and suggested the Fed should be ready to raise interest rates when financial conditions stabilize.
U.S. manufacturing slumped to its weakest in nearly five years in February, the Institute for Supply Management reported. The ISM index slipped to 48.3 -- slightly above economists' consensus forecast of 48.0 -- from 50.7 in January. A reading below 50 means the sector is contracting, while a reading above 50 points to expansion.
This reinforced worries the world's largest economy is headed for recession, though the details of the slide were not quite as weak as analysts' expectations, allowing investors a bit of respite from their recent flight to safety.
"When you look at the numbers we got today, they weren't really unfriendly for bonds," said David Coard head of fixed-income sales and trading at the Williams Capital Group in New York. "It is not like the stock market rallied, so I have to believe this is a technical thing and people are just taking profits."
Two-year notes were down 1/32 in price, pushing yields up to 1.64 percent from their late-Friday level of 1.63 percent.
The benchmark 10-year note fell 11/32 in price, which pushed yields up to 3.56 percent from 3.52 percent late on Friday. Benchmark 10-year notes saw their biggest fall in yields last week since October.
Prices on 30-year long bonds were down 17/32, pushing yields up to 4.44 percent from 4.41 percent late on Friday.
The retreat in bonds suggested markets were taking the ISM news in stride after days of dismal economic news.
The alarm bells of U.S. recession were already ringing louder on Friday as reports showed business activity in the U.S. Midwest plummeted in February and consumer sentiment slumped to a 16-year low.
Analysts said the bond market might have reached a point of saturation with grim news, and the signs of economic distress may have to to reach a new, more troubling level to inspire further price gains.
"We need some new news to move yields lower. More of the same is not going to do it," said James Caron, co-head of global rates research at Morgan Stanley in New York.
As Plosser suggested, there also might be reason at least to keep an eye on inflation, the historic nemesis of bonds since it eats away the value of fixed income.
Inflation pressures have indeed become a significant issue for the bond market in a short amount of time and could exacerbate problems for the consumer and confound the Fed.
For example, the break-even point for the 10-year Treasury inflation-indexed security -- a widely-followed gauge of inflation expectations -- rose to 2.45 percent at the end of February, matching a high from early November 2007, according Reuters EcoWin.
"This means that the public's inflation expectations, which Fed Chair Bernanke has mentioned three times since January 17th as being key to the Fed's ability to continue easing interest rates, have gone from being a non-factor to a big potential problem in just the past month," said John Kosar, president of Asbury Research, in a note.