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Treasurys surge on service sector downturn

February 06, 2008 | "Associated Press"

Bellwether report from the Institute for Supply Management shows nonmanufacturing activity fell well below analyst expectations.

Treasury prices rallied on recession fears Tuesday after a survey showed the services sector shrank for the first time in five years last month.

The Institute for Supply Management's index of nonmanufacturing activity declined to 44.6 in January from a revised reading of 54.4 for December. The result was well below analysts expectations. All readings below 50 indicate contraction.

The news was unsettling because for years the services sector has been one of the engines of the economy and has helped to offset the fact that U.S. manufacturing is in a lengthy decline.

The data sparked heavy early losses in the stock market and sent Treasury prices sailing higher. Investors often sell stocks and opt for Treasurys, which carry a government guarantee, when they are worried about the economy.

The benchmark 10-year Treasury note rose 17/32 to 105 14/32 with a yield of 3.58%, down from 3.64% in late trade Monday, according to BGCantor Market Data. Prices and yields move in opposite directions.

The 30-year long bond rose 24/32 to 110 29/32 with a 4.33% yield, down from 4.37% late Monday.

The 2-year note gained 8/32 to 100 11/32 with a yield of 1.93%, down from 2.07% late Monday.

The 2-year note yield is now within striking distance of the historic low of 1.83% that it reached last month during heavy rallies. The yield is highly sensitive to interest rate policy. Traders often push it lower to signal they expect the Federal Reserve to lower the Fed funds rate to stimulate a faltering economy.

New recession alarms sends futures lower

The service sector is vital to the economy because it accounts for 84% of the 138 million jobs in the U.S., according to Tony Crescenzi, fixed-income analyst at Miller Tabak. The sector is often defined as the "soft" part of the economy - including insurance, government, tourism, banking, retail, education and social services - in contrast to heavy industry.

Some economists will use the new ISM figure to argue that the U.S. has entered a recession. It follows news late last week that the economy lost 17,000 jobs last month. However, a recession consists of two quarters in a row of economic contraction as measured by the gross domestic product and can only be declared in hindsight.

Paul Kasriel, chief economist at Northern Trust said he is in the camp that believes a recession is under way.

"The recession in housing is migrating to the rest of the economy," Kasriel said. "The housing boom created a lot of jobs and the bust extinguished them. When housing prices fall, homeowners have less equity that they can extract from their house, so they have less money to spend. There is a chain reaction that affects everything."

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