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U.S. Treasuries troubled as factory costs doubled
By Pedro Nicolaci da Costa
Sep 15, 2005 4:51 PM ET

NEW YORK, Sept 15 (Reuters) - U.S. Treasury debt prices slid on Thursday after data showing a massive jump in manufacturing costs in September generated anxiety about rising inflation in the wake of Hurricane Katrina.

The Philadelphia Federal Reserve's regional factory gauge plummeted this month, a fact that ordinarily might have given the government debt market a sizable boost.

But accompanying the stagnation in the sector was a doubling of prices paid by manufacturing firms, which suggested the inflation outlook might have worsened severely in September.

That worry sent benchmark 10-year notes reeling 11/32 lower for a yield of 4.22 percent, up from 4.17 percent on Wednesday.

"The Philly Fed shows a collapse ... with a surge in prices," said Andrew Brenner, head of fixed-income at Investec U.S. "This will give the Fed a real conundrum."

The central bank meets next week to set monetary policy. While most on Wall Street predict the Fed will raise interest rates by another quarter percentage point, another wave of weak data could force them to pause later in the year.

However, if inflation outside the energy sector begins to show visible acceleration, Fed officials would be caught in a difficult spot as they look to keep the economy growing without stoking pervasive prices increases.

For now, bond investors appeared more focused on inflation risks than on the threat to growth from Hurricane Katrina and high energy costs.

This emphasis sent the 30-year bond a full point lower for a yield of 4.52 percent, up from 4.45 percent. Five-year notes dropped 5/32 for a yield of 4.00 percent, up from 3.96 percent.

Two-year notes suffered the least, easing only 1/32 to yield 3.90 percent from 3.89 percent.   The discrepancy between long and short maturities helped steepen the yield curve, with the spread between 10- and two-year notes widening four basis points to 32.


Traders got a full serving of economic data on Thursday, but investors paid most attention to numbers showing the state of economic activity after Hurricane Katrina.

The Philadelphia Fed's index of mid-Atlantic factory activity plunged to 2.2 in September from 17.5 in August, far below economists' forecasts for a drop to 14.0.

The new orders index, a key indicator of future growth, dropped into negative territory for the first time since April 2003, falling to minus 0.5 in September from 19.8.

Growth at New York State factories also slowed in September, bogged down by fewer orders and higher costs, but the drop was less significant than that seen in the Philly Fed and was more or less in line with forecasts.

The New York Fed's 'Empire State' index of overall conditions for manufacturers fell to 16.97 from August's 23.04, pretty much in line with market expectations.

Yet the bond market did not manage to make any strides on the figures, mostly because the survey's "prices paid" component soared to 52.7 from 25.9.

"That's where the market should be focused -- on the emerging inflation risk," said Josh Stiles, senior bond strategist at IDEAglobal. "This is where the pricing risk exists, because everbody has been saying that there is no inflation."

That may have been the case before Katrina hit. The Labor Department said on Thursday that its consumer price index rose 0.5 percent in August, but excluding energy and food it ticked up a contained 0.1 percent.

But that was backward looking data, and analysts feared the post-Katrina world might look a lot different.

© Reuters 2005. All Rights Reserved.

Energy cost increases ALWAYS cause inflation. ALWAYS. And the only way to kill inflation is to have a recession. What is the Fed waiting for? Interest rates will have to rise, inflation will soar and we're headed into recession. It's not a question of if we'll have a recession, but when.

As usual, Greenspan and the Federal Reserve are behind the curve--always trying to catch up. When will this man do his job?