Since April 11th, bonds have rallied almost without fail due to the general shift in economic sentiment. Things have been so good in fact, that you could set your watch to bond markets' ability to bounce back from short term losses. But don't let that precedent lull you into a false sense of security about the absence of short term backups. It might seem like we're just trying to keep the analysis balanced when we mention the risk of short term pull-backs, but in the context of broader rallies they are all but guaranteed. We simply haven't seen a good example of one in the current rally, YET. Chalk that up to the rapid shift in economic sentiment. In the grand scheme of things, it's almost like the last two months of strength came out of nowhere. Even in early May, it's easy to see marked differences in the views expressed by Fed Speakers. Bottom line, bond and stock markets have had a lot of adjusting to do in a relatively short amount of time, and this hasn't allowed for the normal amount of back and forth seen during extended rallies. But today looks like it may be the first good example of that. Reason being: we have the single largest uptick in 10yr yields since 4/11 and the biggest surge of volume to boot. The high volume and rapid sell-off deposited yields squarely on the other side of the 3.055 technical level and quickly slammed the door. 3.055 was tested on numerous occasions as resistance in late may and we haven't seen it again since. So the combination of the SIZE of the move, the VOLUME, and the LEVELS to which it has taken yields, all on economic data that was still bearish overall, but simply less bearish than expected clearly suggests that the strength of the recent rally has been due to some front-running of the worsening economic picture and that they are viewing this morning's data as a valid piece of information in moderating their otherwise bond-friendly trajectory.

(Reuters) - U.S. business inventories rose modestly in April amid a small increase in stocks of motor vehicles, a government report showed on Tuesday. The Commerce Department said inventories increased 0.8 percent to $1.50 trillion, the highest level since October 2008, after increasing by an upwardly revised 1.3 percent in March. Economists polled by Reuters had forecast inventories rising 0.9 percent after a previously reported 1.0 percent increase in March. Inventories are a key component of gross domestic product changes and April's modest gain suggested restocking could have a neutral effect on second-quarter GDP. Motor vehicle inventories rose 0.3 percent after increasing 1.2 percent in March. A shortage of motor vehicle parts following the earthquake in Japan has disrupted production, leaving stocks lean. Business sales edged up 0.1 percent, the weakest advance since June 2010, after rising 2.4 percent the prior month. April's weak sales pace raised the inventory-to-sales-ratio -- which measures how long it would take to clear shelves at the current sales pace -- to 1.26 months from 1.25 months in March. (Reporting by Lucia Mutikani, Editing by Andrea Ricci)

Rate sheets are expected to worsen this morning after bond markets reacted negatively to 830am Retail Sales and Producer Price data. The Fannie Mae 4.0 MBS coupon is -13/32 at 100-13. Loan pricing will likely deteriorate by 25 - 40bps as a result.

(Reuters) - U.S. producer prices rose more than expected in May but the pace of increases eased from prior months as the climb in energy costs slowed, according a report on Tuesday. The Labor Department said producer prices climbed 0.2 percent, double what analyst forecasts in a Reuters poll but down from April's 0.8 percent increase. Compared to a year earlier, prices surged 7.3 percent, the largest rise since September 2008, just as the financial crisis took a turn for the worse and dragged prices lower globally. Excluding food and energy, wholesale prices jumped 0.2 percent, while year-on-year core inflation remained at 2.1 percent, its highest since August 2009. (Reporting by Pedro Nicolaci da Costa; Editing by Padraic Cassidy)

(Reuters) - Retail sales fell in May for the first time in 11 months, dragged down by a sharp drop in receipts from auto dealerships, according to a government report that could raise fears of a prolonged economic slowdown. Total retail sales slipped 0.2 percent, the Commerce Department said on Tuesday, after a downwardly revised 0.3 percent increase in April. Economists polled by Reuters had forecast retail sales falling 0.4 percent from April's previously reported 0.5 percent rise. In the 12 months to May, retail sales were up 7.7 percent. Retail sales last month were depressed by a 2.9 percent drop in sales of motor vehicles, the largest decline since February 2010, as a shortage of parts following the earthquake in Japan left inventories lean and prompted manufacturers to raise prices. Excluding autos, retail sales rose 0.3 percent last month, the smallest gain since July, after rising 0.5 percent in April. The report was the latest in a series of weak data to show the lull in economic activity extending well into the second quarter. The economy started the year on a soft note beset by bad weather and rising oil prices. Economists pin much of the recent weakness on high gasoline prices and supply chain disruptions from the earthquake and tsunami in Japan and say a new recession is not in the offing. Receipts at gasoline stations rose 0.3 percent after increasing 1.4 percent the prior month. Excluding gasoline, retail sales fell 0.3 percent after gaining 0.1 percent in April. The report painted a generally weak picture of consumer spending, with sales at food and beverage stores falling 0.5 percent, while receipts at sporting goods, hobby, book and music stores dropped 0.4 percent. Sales of electronics and appliances fell 1.3 percent, the largest decline since March 2010. However, clothing store receipts edged up 0.2 percent last month, while sales at building materials and garden equipment suppliers rose 1.2 percent.

(NFIB) - For the third consecutive month, NFIB’s Small Business Optimism Index fell. While the drop was slight—.3 points, with the index settling at 90.9 in May—the index makes clear that optimism is moving in the wrong direction: a recession-level reading for an economy fighting its way through a recovery. A leading cause of the low reading is the stubborn problem of weak consumer spending, which is especially problematic for services, a sector dominated by small businesses. “Corporate profits may be at a record high, but businesses on Main Street are still scraping by,” said NFIB chief economist Bill Dunkelberg. “Washington is throwing misdirected policies at the problem, offering tax breaks for hiring and equipment investment, but acting surprised when they don’t bear any fruit. The failure to understand why small-business owners are not hiring or investing has resulted in a set of policies that have not been very effective, and Main Street is suffering. The icing on the cake: the growing debt, large deficits, threats of higher taxes, regulations being spewed out by state and local administrations, and the uncertainty of the new health care law—is it any wonder that optimism is down?” For the third month running, several key economic indicators continued their downward tumble. Job market indicators continued to deteriorate, anticipating very weak job creation and a higher unemployment rate. Capital spending plans and inventory investment plans all weakened and remain at recession levels. Inflation continues to rise, a notable business concern for owners who are raising their own prices at the fastest pace seen in years. And driving the economic uncertainty, one in four owners still report weak sales as their top business problem (followed by taxes and regulations and red tape, only 3 percent cite financing).