TREASURIES-Prices fall, yield curve steepens on inflation risk

Thu Jul 31, 2014 9:31am EDT

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* Yield curve steepens from five-year lows
    * Benchmark 10-year note yields highest in four weeks
    * Inflation risk seen as labor costs rise

    By Karen Brettell
    NEW YORK, July 31 (Reuters) - U.S. Treasuries yields rose on
Thursday as rising labor costs led some investors to prepare for
a greater likelihood that the Federal Reserve will increase
interest rates next year, while others feared that inflation may
be a higher risk if the U.S. central bank is too slow to hike
rates.
    Data on Thursday showed that U.S. labor costs recorded their
largest increase in more than 5-1/2 years in the second quarter,
a sign that a long-awaited acceleration in wage growth was
imminent. 
    The data comes after gross domestic product on Wednesday
showed a strong rebound in the second quarter from a weak start
to the year. 
    "Starting with GDP yesterday, it certainly set things off,"
said Ira Jersey, an interest rate strategist at Credit Suisse in
New York. "In general, you have decent data and if the Fed's
behind the curve, you will wind up with inflation running a
little bit higher than people thought."
    The yield curve steepened as investors adjusted to the
prospect of higher inflation. The yield gap between five-year
notes and thirty-year bonds steepened to 156 basis points, up
from a five-year low of 149 basis points on Wednesday.
    Benchmark 10-year notes fell 10/32 in price to
yield 2.60 percent, the highest since July 8.
    The Fed reiterated on Wednesday that it would likely keep
rates near zero for a "considerable time" after its bond buying
ends and restated that an "accommodative" policy was needed in
the statement from its July meeting.
    The central bank acknowledged higher prices but also
expressed concern about remaining slack in the labor market.
 
    Many expect that the Fed will adopt a more hawkish tone and
offer more details about its exit strategy when it next meets in
September. The Fed is now evaluating a wide range of employment
data as guides for interest rate policy, however, which may also
keep it on hold for longer.
    Higher yields since Wednesday's GDP data indicated traders
are pricing for higher inflation or the likelihood that the Fed
will raise rates next year if the economy continues to improve.
    A Morgan Stanley index meant to gauge the timing of the
first interest rate hike (M1KE) on Wednesday suggested that an
increase may occur within 12 months, the first time since 2011
that the index has indicated one will occur within a year, an
analyst at the bank said in a report on Wednesday.
    Based on this indicator, two-year note yields should pay
0.68 percent, the bank added. That is 10 basis points higher
than the notes' current yield of 0.58 percent.
    The next major focus will be Friday's jobs report for July.
Employers are expected to have added 233,000 jobs in July
according to the median estimate of 100 economists polled by
Reuters. 
    

 (Editing by Nick Zieminski)
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