MBS MID-DAY: Bouncing Back as Stocks Sell

(Reuters) - U.S. construction spending fell unexpectedly in July as public construction outlays dropped to their lowest level since December 2006 and private spending also sagged, a government report showed on Thursday. Construction spending fell 1.3 percent to an annual rate of $789.5 billion, the largest drop since January, the Commerce Department said. However, June's construction spending was revised to a 1.6 percent increase rather than the previously reported 0.2 increase. Economists had expected construction spending to rise 0.2 percent in July.

(Reuters) - The pace of growth in the U.S. manufacturing sector ticked down to a crawl in August but fared better than economists had forecast, an industry report showed on Thursday. The Institute for Supply Management said its index of national factory activity edged down to 50.6 from 50.9 the month before. The reading topped expectations of 48.5, which would have signaled a contraction, according to a Reuters poll of economists. A reading above 50 indicates expansion in the manufacturing sector. Analysts had been expecting the data to show the first contraction since July 2009, just after the recession officially ended. New orders rose to 49.6 from 49.2, while the employment gauge dipped to 51.8 from 53.5. (Reporting by Leah Schnurr; Editing by Padraic Cassidy)

Markets had been expected a sub-50 reading on the just-released ISM report and they got 50.6. The simple fact that this indicates expansion rather than contraction is causing a knee-jerk reaction in markets (or maybe it's the simple fact that it's still horribly weak and making stocks hope for QE3?). MBS are down to yesterday's lows with 4.0's at 103-16. 3.5's are down to 100-12. Reprices for the worse are quite possible from any lenders who were already out with rates.

The overnight session was mostly kind to Treasuries and to a smaller extent, MBS. The ECB is still buying Italian and Spanish bonds, but the dealer community has to do the heavy lifting at auctions as evidenced by Spain's 1.8 bid-to-cover last night vs 2.54 average. Volume was pretty light and excitement pretty low to kick off the new month. Even after our own 830am econ data, 10's and MBS are flat at opening levels: 3 ticks better in Fannie 3.5's and 4.0's at 100-24 and 103-25 respectively. 10yr notes are about 2bps lower at 2.213. Rate sheets out before the 10am ISM Manufacturing report should be similar to yesterday's latest offerings depending on the specific lender's late day reprice-for-the-worse aggressiveness. Otherwise the moderately anticipated ISM data (expected to turn negative for the first time in a long time) could delay rate sheets, but also removes some uncertainty from the day's trading, perhaps allowing lenders to price more in line with any improvements or declines in MBS.

(Reuters) - U.S. nonfarm productivity was weaker than previously thought in the second quarter and wage growth was a bit stronger, but not enough to ignite inflation pressures. Productivity fell at a 0.7 percent annual rate, the Labor Department said on Thursday, the biggest decline since the fourth quarter of 2008. That was a downward revision to its previous estimate of a 0.3 percent fall. Productivity, which measures hourly output per worker, fell at a 0.6 percent rate in the first three months of 2011. Economists had expected the revision to show productivity dropped at a 0.5 percent rate. The weak productivity is in a line with the anemic economic growth pace during the second quarter. The economy expanded at a 1.0 percent annual rate after a measly 0.4 percent pace in the January-March period. A slowdown in productivity usually suggests that businesses have to add new workers to meet production, but against the backdrop of an economy growing at a near stall-speed, it implies businesses might have to cut costs to protect profits. Productivity grew rapidly as the economy emerged from the 2007-09 recession, peaking at an 8.0 percent growth rate in the second quarter of 2009. The gains were driven by companies' cutting costs, particularly labor. The productivity report showed unit labor costs grew at a more sturdy 3.3 percent rate in the second quarter rather than 2.2 percent. The revised pace is still slower than the 6.2 percent rate in the first quarter, indicating wage pressures remain too well contained to stoke a broader rise in inflation. Economists had expected the growth in second-quarter unit labor costs to be revised up to a 2.4 percent rate. (Reporting by Lucia Mutikani, Editing by Andrea Ricci)

(Reuters) - New U.S. claims for unemployment benefits fell as expected last week, a government report showed on Thursday, showing little sign of a pick-up in layoffs in the wake of a slump in business and consumer confidence. Initial claims for state unemployment benefits dropped 12,000 to a seasonally adjusted 409,000, the Labor Department said, still pointing to a jobs market struggling to find strength, but well short of a recession signal. Economists polled by Reuters had forecast claims falling to 410,000 last week. The prior week's claims were revised up to 421,000 from the previously reported 417,000. A Labor Department official said there were no special factors influencing last week's claims report. The Verizon strike helped to push up claims in the last two weeks. The four-week moving average of claims, considered a better measure of labor market trends, rose 1,750 to 410,250 last week. The number of people still receiving benefits under regular state programs after an initial week of aid dropped 18,000 to 3.74 million in the week ended Aug. 20. The number of Americans on emergency unemployment benefits increased 31,261 to 3.12 million in the week ended Aug. 13, the latest week for which data is available. A total of 7.34 million people were claiming unemployment benefits during that period under all programs, up 45,531 from the prior week. (Reporting by Lucia Mutikani, Editing by Andrea Ricci)