Long bond yields fall, but higher yields may lie ahead
NEW YORK (Reuters) - The Treasury debt prices posted modest gains on Tuesday, but selling still pushed some yields to multi-month highs as traders focused on the idea that a stronger economy could mean quicker inflation and monetary policy tightening sooner than expected.
Price losses were limited, however, and gains returned to the longest-dated U.S. debt - 10-year notes and 30-year bonds.
Recent data has revealed slightly more strength in the U.S. economy than many economists were expecting. While the Federal Reserve has remained inclined to keep rates low, market hopes that it will do another round of quantitative easing are fading.
Economic optimism often means pessimism for Treasuries' performance. Tuesday's extension of the recent Treasuries rout pushed the five-year yield to levels last seen on August 8, 2011.
"You are going to trade horizontally over the next couple of days, and then it's going to be a test of the 2.53 percent 10-year yield mark," said Eric Green, chief economist and head of rates strategy at TD Securities in New York.
"The risk is, if you get up toward 2.48 percent, you could create a reinforcing move that could get out of hand really quickly in terms of the sell-off getting stretched," he added.
Treasury yields, kept low for nearly four months by dovish signals from the Fed, began rising after the Federal Open Market Committee's March 13 monetary policy-setting meeting did not result in another round of easing measures.
"People are starting to hedge against the idea that we could be looking at much higher rates," said Rick Klingman, a Treasury trader at BNP Paribas in New York.
"The selling is coming not only in the seven- to 10-year part, but also in the three- to five-year part. There are some real adjusting thoughts going on for how long the Fed will be on hold."
The latest sign of economic strength came bundled in data on housing starts for February. The Commerce Department said U.S. housing starts fell in February, but permits for future construction jumped to their highest since October 2008.
The benchmark 10-year U.S. Treasury note rose 5/32 in price and yielded 2.36 percent, down from 2.38 percent late on Monday, while the 30-year bond added 18/32 in price to yield 3.45 percent, down from 3.48 percent at Monday's close.
The 10-year note's yield touched a 4 1/2-month high of 2.399 percent on Tuesday during a bout of selling. The five-year note was last trading unchanged in price and yielding 1.20 percent, but it, too, hit a yield high earlier on Tuesday. The five-year yield touched 1.23 percent, the highest in over seven months.
"People are just not sure where the yields are going to settle," said Boris Rjavinski, U.S. rates derivatives strategist at UBS Securities in Stamford, Connecticut. "For people to go in and really start buying Treasuries right now would be like catching a falling knife."
Still, yields remain near historic lows. The 10-year yield of 1.67 percent in September 2011 was the lowest in at least 60 years.
"It would be natural to assume that since a bottom in bonds has been established, the smart thing to do would be to call for a rapid 2009-style backup in long-term rates," said Steven Ricchiuto, chief economist at Mizuho Securities in New York.
"Although such an outcome cannot be ruled out, it is not our central call. Instead, our new market call is for the 10-year note to establish a new 2 percent to 2.5 percent trading range and to hold this range through at least the summer," he said.
"We find it hard to fight the Fed," Ricchiuto said, referring in part to the central bank's latest stimulus program, nicknamed "Operation Twist".
On Tuesday, the Fed bought $1.969 billion of Treasuries maturing February 2036 through February 2042 as part of Operation Twist.
There was some evidence that the recent rise in yields may have run its course.
The share of investors who said on Monday they are long, or owning more Treasuries than their portfolio benchmarks, rose to 25 percent from 21 percent the previous week, matching the level seen two weeks ago, J.P. Morgan Securities' latest weekly Treasury client survey showed.
Following last week's sharp market sell-off, the share of investors who said they are short U.S. government debt, or holding fewer Treasuries than their benchmarks, fell to 15 percent, down from 23 percent the previous week.
"The Treasury market appears to be in the early stages of tracing out a new higher range. There are no signs yet that this is the beginning of a sustained bear move," William O'Donnell and John Briggs, strategists at RBS Securities in Stamford, Connecticut, said in a research note.
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