US Treasury debt prices retreated on Tuesday after a report on the US services sector showed a surprisingly robust gain for August, suggesting the economy was on a strong footing before Hurricane Katrina.
The exact tally of economic damage from the hurricane remains a mystery. But analysts believe it was sufficiently large to prompt the Federal Reserve to rethink its strategy of steady interest rate increases - at least temporarily.
Most investors still expect the central bank to raise rates by a quarter percentage point later this month, but many now foresee a pause at either the November or December meeting.
"We still have two more rate hikes this year in our forecast, but the probability of a pause has now gone up," said Rick Egelton, chief economist at BMO Financial Group.
Still, the startling and broad-based jump in the Institute for Supply Management's services index was enough to send benchmark 10-year notes 13/32 lower for a yield of 4.10 percent, up from 4.04 percent Friday. Rising equity markets were also sapping strength from safe-haven bonds, with the major averages up well over 1 percent.
Before Katrina, economists had been predicting solid growth in the second half of the year, although worries about soaring energy costs and a potential easing of the housing market were already simmering.
The Hurricane tempered rosy forecasts, setting the stage for last week's huge rally in short-term debt. But traders appeared ready to give up some of those gains, particularly with oil prices receding closer to $66 a barrel.
Two-year notes slipped 3/32 for a yield of 3.81 percent, compared with 3.77 percent on Friday. Five-year debt was down 7/32 and yielding 3.90 percent, while the 30-year bond lost a 1-3/32 for a yield of 4.36 percent.
Investors will comb through weekly chain store sales data on Wednesday morning for a sense of the storm's impact on consumer spending.
Analysts note that the overall economic impact of such natural disasters tends to be neutral, since reconstruction efforts offset the drag from job and property losses.
However, energy is the big question mark in this instance, since so many refineries were shut down or incapacitated.
Retail prices for gasoline are topping $3 a gallon in many parts of the country, and pessimists fear it is only a matter of time before consumers cut back spending on other products.
The summer's energy drag had yet to affect the services sector negatively, if the monthly ISM report was any guide.
The jobs index rose to 59.6 from 56.2, while new orders jumped to 65.8 from 61.9. The index denoting prices paid by service companies fell to 67.1 from July's 70.3, something of a surprise given the strong rise in energy costs.
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