US Treasury debt prices declined on Friday as rising inflation and a sharp improvement in Midwest business conditions reaffirmed the likelihood of further interest rate hikes from the Federal Reserve.
That prospect was most evident in short-term debt, where two-year note yields hit 4.19 percent, their highest level in over four years. The index of Chicago-area purchasing managers (PMI) showed a drop in hiring, but the overall message was clear: Hurricane Katrina does not appear to have derailed economic growth, leaving the Fed plenty of room to tighten monetary policy.
"Katrina ironically may have had a positive effect on this index because of the big surge in orders," said Cary Leahey, senior managing director at Decision Economics.
Also corrosive for bonds, the Fed's favourite measure of inflation - known as the core PCE - hit the ceiling of the central bank's presumed comfort range, suggesting inflation pressures were becoming more pervasive than many believed.
Against that backdrop, bonds derived little comfort from a plunge in consumer confidence, in part because traders care much more about what consumers do than about what they say.
Benchmark 10-year notes lost 7/32 to yield 4.33 percent, their highest in six weeks and up from 4.30 percent on Thursday.
Five-year notes retreated 5/32 to yield 4.20 percent from 4.15 percent, while the 30-year bond backed up 12/32 to yield 4.57 percent.
The rebound in Midwest business activity prompted many investors to second guess the perception that the fallout from Hurricane Katrina would have an adverse effect on the national economic outlook.
The National Association of Purchasing Management-Chicago's business barometer jumped to 60.5, almost fully reversing a drop to 49.2 in August and far surpassing forecasts for a modest gain to 51.0.
Analysts said the report showed that the US economy had significant momentum going into Hurricanes Katrina and Rita over the past month. New orders raced to 63.4 from 46.5 in August, although the jobs index fell to 48.4 from 51.7.
On the inflation side, the core personal consumption expenditures index rose a 0.2 percent, double expectations. That brought the year-over-year increase to 2 percent, which is likely to make Fed officials cringe about price trends.
Energy prices pushed overall consumer inflation up 0.5 percent, the largest jump since September 1990, while personal spending fell an unexpectedly steep 0.5 percent.
Consumer sentiment did deteriorate sharply in September, but was little changed from a mid-month reading, suggesting the post-hurricane damage to confidence was temporary.
The University of Michigan's index of consumer sentiment slumped to 76.9 in September, the lowest in over a decade. That was the same as a mid-month reading but off from 89.1 in August.
Still, analysts would wait from confirmation of any lasting retreat in consumer spending from retail sales data. Weekly chain store sales had yet to show a severe deterioration after the hurricanes.
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