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Bonds Slip as Stocks Rise on Manufacturing Report

Long-dated U.S. government debt prices slipped Tuesday as data showing U.S. manufacturing expanded in August drew money into stocks and away from bonds.

Bonds reacted negatively as U.S. equities started climbing soon after the Institute for Supply Management report showed manufacturing expanded in August, albeit at a slower pace than in July.

In mid-afternoon trade, the 10-year Treasury note was down 9/32 in price for a yield of 4.56 percent, compared with 4.53 percent late Friday. Bond yields and prices move inversely. In contrast, the Dow Jones Industrial Average was up 79 points, or 0.6 percent.

"We're trading with stocks," said Chris Rupkey, senior financial economist at Bank of Tokyo/Mitsubishi UFJ. "When stocks are up, bond prices are down."

'Timeliest Indicators' and Rate Cuts

Given Federal Reserve Chairman Ben Bernanke's statement Friday that the Fed would pay "particularly close attention to the timeliest (economic) indicators," the signs of continued economic growth in the August ISM manufacturing index made stocks look more alluring than bonds, analysts said.

"At this stage, the 50-line (on the ISM manufacturing index) becomes very important to tell whether the economy is expanding or contracting," said Chris Rupkey, senior financial economist at Bank of Tokyo/Mitsubishi in New York.

The ISM index of national factory activity slipped to 52.9 in August from 53.8 in July, but any reading above 50 reflects expansion.

A crucial issue for the Fed in determining whether it will cut interest rates at its mid-September policy meeting is whether the credit drought that occurred in August will stymie economic growth or even tip the economy into recession. The ISM index showed that, at least so far, that has not happened.

"There's always a first time, of course, but the Fed has never begun a series of rate cuts with the ISM above 50," said Rupkey. "The credit crunch hasn't blown down the economy yet, so bonds lost some ground."

Tuesday marked the return of substantial volume after U.S. bond markets were closed for Monday's Labor Day holiday. Last week, the 10-year note's yield fell below 4.50 percent to its lowest level since March as investors shunned riskier assets and bet that the Fed would cut interest rates to alleviate the potential negative impact of credit market stress on the economy.

In mid-afternoon, the two-year Treasury note was flat, its yield at 4.14 percent, barely changed from Friday. Analysts cautioned that the safe-haven bid for high-quality U.S. government debt could return if the corporate funding and credit problems that gripped markets in August reemerge.

"My focus is on how well these deals on the books of these big banks get distributed," said Charlie Smith, chief investment officer of Fort Pitt Capital Group in Greentree, Pennsylvania. "If they don't get distributed in any comfortable way, then the fear trade into short-term Treasury paper will come back," he said.