10-year Treasury yield pops above 4%

Federal Reserve rate hike also weighs on Treasuries, dollar reaches highs against euro.

July 1, 2005: 1:29 PM EDT


NEW YORK (CNN/Money) - Treasury prices dipped Friday and the dollar posted multi-month highs as markets digested mixed readings on the economy and the Federal Reserve's rate hike late Thursday, its ninth in a row.

The benchmark 10-year note tumbled 1 point to 100-21/32, to yield 4.04 percent, up from 3.91 late Thursday, while the 30-year bond sank 1-28/32 points to yield 4.30 percent, up from 4.19 in the previous session. Treasury prices and yields move in opposite directions.

The five-year note fell 18/32 to yield 3.83 percent, while the two-year note dropped 6/32 to yield 3.74 percent.

The Treasury market gave more weight to two reports that showed economic expansion and downplayed a weaker-than-expected construction release.

The Institute for Supply Management's purchasing managers survey showed that manufacturing growth strengthened in June, picking up the pace from a recent slowdown.

The ISM's closely watched manufacturing index rose to 53.8 last month, up from 51.4 in May. Economists surveyed by Briefing.com expected a slight gain to 51.5.

"There had been talk of that coming in under 50. It came in at 53.8. It's a negative for the bond market, but actually doesn't look so bad for the economy," Evan Rourke, a bond strategist at Popular Securities in New York, told Reuters.

And the University of Michigan's June consumer sentiment index was upwardly revised to 96 from 94.8. Economists surveyed by Briefing.com had expected the index to edge lower to 94.6 for the month.

A construction spending report that came in weaker-than-expected held less sway over the market, May spending down 0.9 percent. Analysts surveyed by Reuters were expecting a 0.5 percent increase.

Analysts said investors were also squaring their books leading up to the long Fourth of July weekend.

Bonds rose Thursday after the Fed, the nation's central bank, raised the federal funds rate, an overnight bank lending rate, to 3.25 percent, the highest since just before the September 2001 terrorist attacks.

In theory, more rate hikes should force bond investors to realize that the economy is in decent shape and cause bonds to sell-off and push yields higher.

But long-term yields have remained low despite a year of fed fund rate hikes, causing short- and long-term yield levels to move closer together. This is known as a flattening yield curve.

Traders may have held onto bonds in the face or rising short-term rates because they believe the hikes mean the Fed has inflation well in hand. Inflation hurts bonds by eroding the value of the fixed-income investment.

When short-term yields become higher than long-term yields, it is called an inverted yield curve. An inverted yield curve has preceded the nation's last two economic recessions. (Confused about yield curves? Click here for help.)

The Fed's pledge that it would keep increasing rates at a "measured" pace was as influential as the widely expected quarter-point increase.

The phrase, used in every Fed statement since May 2004, means another quarter-point hike is likely when Fed Chairman Alan Greenspan and other Fed policy makers meet again Aug. 9. While another rate hike is expected in August, the debate continues over whether the Fed will stop raising rates after August's meeting.

In currency trading, the dollar jumped against the euro and extended its rally against the yen.

The euro reached a 13-month low Friday, buying as low as $1.1942 before climbing to $1.1961 by the early afternoon, down from $1.2094 late Thursday. The dollar bought ¥111.66, up from ¥110.92 the previous session.

Rising rates, combined with Europe's struggling economy and political upheaval, have helped spark a dollar rally, driving the currency up more than 10 percent against the euro and nearly 7 percent against the yen this year. At the start of the year most investors had been betting the dollar would decline.