Treasurys rally on recession fears

NEW YORK (CNNMoney.com) -- Bond prices rose Thursday after the Philadelphia Federal Reserve said its manufacturing index unexpectedly sank 20.9 percent in January, highlighting fears that the economy is headed for recession.

Economists had not expected the index to fall more than 7 percent, according to the Associated Press.

The news came as Federal Reserve Chairman Ben Bernanke testified before Congress, urging lawmakers to act quickly to provide an economic stimulus plan.

The Fed chairman also said the economic outlook has worsened, fueling demand for the relative security of government bonds.

Bernanke has signaled the central bank's willingness to lower its benchmark federal funds rate when the monetary policy committee meets January 29-30, though there is some speculation that a rate cut could happen before the meeting.

However, the possibility of an interest rate cut was not enough to help stocks overcome more worrisome economic news Thursday.

According to a government report, housing starts and building permits plunged in December resulting in a full-year decline in new home construction that was the sharpest drop in 27 years.

In corporate news, the nation's largest brokerage Merrill Lynch (MER, Fortune 500) posted a $10 billion loss for the fourth-quarter and announced a $14.6 billion in writedowns due to subprime mortgages and hedges gone bad.

The benchmark 10-year Treasury note shot up 26/32 to 105 2/32 with a yield of 3.63 percent, down from 3.74 percent late Wednesday. Prices and yields move in opposite directions.

The 30-year long bond gained 1 12/32 to 112 15/32 with a yield of 4.25 percent, down from 4.35 percent late Wednesday.

The 2-year note rose 4/32 to 101 17/32 with a yield of 2.45 percent, down from 2.51 percent the day before.

The yield on the 3-month note fell to 3.07 percent from 3.14 percent while the discount rate dropped to 3.00 percent from 3.07 percent.

Oil prices fell. The dollar slipped against the euro and the yen.