NEW YORK (MarketWatch) -- Treasury prices gained Wednesday after the government said U.S. retail sales fell last month by the most in three years, resurrecting concern that the economy continues to weaken.
Two-year note yields fell nine basis points, or 0.09%, to 1.76%. Yields move in the opposite direction of prices.
The Commerce Department said sales declined 1.2% in September. The median forecast of economists surveyed by MarketWatch had been for a 0.8% decline.
Excluding automobiles, retail sales fell 0.6% last month, also more than anticipated. See Economic Report.
Also on the data front, manufacturing activity in the New York region deteriorated sharply in October, as the New York Federal Reserve Bank's Empire State Manufacturing index plunged to a record negative 24.6 in October -- far worse than the reading of negative 7.4 seen in September.
"Any euphoria over the notion that government actions are finally attacking one of the root problems of the crisis is rapidly dissipating," said William O'Donnell, U.S. government bond strategist at UBS Securities.
A separate report showed U.S. producer prices fell 0.4% last month, less than expected. See full story.
Treasurys traded higher before the reports, as policy makers acknowledged that recent, dramatic government initiatives to support financial institutions won't stem the economic deterioration underway.
"The U.S. economy appears to be in a recession," said San Francisco Federal Reserve President Janet Yellen in a speech delivered late Tuesday.
Investors may also be disappointed that efforts to shore up bank finances hasn't eased rates in short-term lending markets, which set benchmarks on loans for everything from companies to mortgages and car financing.
The London interbank offered rate, or Libor, for three-month dollar loans declined to 4.55% from 4.635% on Tuesday. See full story.
"A worst-case interpretation is that losses are going to prove so much greater than anticipated that banks will continue to hoard cash until they believe they've fully accounted for the potential damage," said T.J. Marta, fixed-income strategist at RBC Capital Markets.
Also on traders' radar screens, Federal Reserve Chairman Ben Bernanke will be speaking on the economic outlook and financial markets at 12:15 p.m. Eastern time. The Fed will also release its so-called Beige Book, a collection of anecdotes illustrating economic conditions from its regional branches.
Rate cut more likely
Futures traders raised bets that a continuing slide in growth will compel the U.S. central bank to lower its target interest rate again at the end of the month, after a surprise reduction last week to 1.5%.
The November federal funds futures contract indicated a 62% chance that rates will be cut by a further half a percentage point at the Fed's Oct. 29 policy meeting.
Futures also indicate more investors are anticipating borrowing costs will continue to decline at the December meeting and into 2009.
The number of fund managers that believe the global economy is already in recession jumped to 69% in October, up from 44% in September, according to the latest survey compiled by Merrill Lynch. More than seven in 10 say that short-term interest rates will be lower in a year, compared with a reading of 51% a month ago. See FundWatch.
