Treasurys rallied on Tuesday as a drop in Christmas sales and Citigroup's first ever quarterly loss sent stocks sharply lower, rekindling investors' penchant for safety.
Citigroup wrote off a colossal $18.1 billion and posted a fourth-quarter loss of $9.83 billion, a reminder that the financial sector was still reeling from bad bets on the mortgage sector.
The housing downturn was affecting consumers as well.
December retail sales fell 0.4 percent, worse than expected and a particularly disappointing result given the importance of the holiday shopping season for retailers.
"This puts pressure on the Fed to cut interest rates," said Michael Metz, chief investment strategist at Oppenheimer & Co.
Taken together, these developments renewed fears about a possible recession, propelling benchmark 10-year notes 11/32 higher for a yield of 3.73 percent, down four basis points on the day and near their lowest in 3-1/2 years.
Short-term interest rate futures jumped immediately after the data's release, showing as much as a 56 percent chance the Fed will slash rates by 75 basis points, compared with a 44 percent chance late on Monday. Futures fully price a rate cut of 50 basis points by the Fed at the Jan. 29-30 meeting.
The stock market posted sharp losses, fueling the gains in bonds. The Dow Jones industrial average was down over 200 points or 1.6 percent.
Bond traders appeared reluctant, however, to push the market any higher ahead of a key release on consumer prices due out on Wednesday morning.
Some worry the Treasury market has underestimated inflation risks, which erode the value of fixed-income returns.
"The bond market is going to be much more sensitive to inflation news," said Carley Garner, senior analyst at Alaron Trading in Las Vegas.
A separate indicator of inflation recently breached the presumed 2 percent ceiling of the Fed's comfort range. The December CPI is expected to post a 2.4 percent year-on-year gain.