(Adds strategist quotes, updates prices, changes byline)
* Bonds plunge on inflation worries
* More expect inflation may spur the Fed to raise rates
* Lower than expected jobless claims add to weak tone
By Chris Reese
NEW YORK, May 22 (Reuters) - U.S. Treasury debt prices plunged on Thursday as worries over rising inflation, fueled by soaring energy prices, boosted expectations the Federal Reserve might have to raise interest rates to fight price pressures.
Thus far, U.S. government bonds have shown extraordinary resistance to escalating global food and energy costs, based on the view that their main impact would be to cause economic weakness.
But fixed income analysts have long warned that should energy and food price surges become ingrained trends, longer-maturity bond yields may spike at some point. Inflation erodes a bond’s value over time.
“The overall concern for the Fed and the market right now is that the inflation picture is probably not going to fade as fast as the Fed thought it would,” said John Spinello, Treasury bond strategist at Jefferies & Co in New York, adding “there has been a pretty significant amount of liquidation in the back end of the market.”
The inflation-sensitive 30-year bond US30YT=RR traded 1-11/32 lower in price for a yield of 4.63 percent from 4.54 percent late on Wednesday, while the benchmark 10-year note US10YT=RR traded 30/32 lower for a yield of 3.92 percent from 3.81 percent.
While most analysts expect the Fed to maintain the current level of interest rates at its next policy meeting in June, more are now speculating that rising inflation will force the U.S. central bank to reverse its campaign to loosen monetary policy and begin to raise rates later this year.
Fed fund futures on Thursday hit new highs on ideas for an October rate hike, implying as much as a 72 percent chance of a rate increase. Futures also point to about a 33 percent chance of a rate hike in September.
“The low inflation rate that we have enjoyed for a long period of time is probably going to be breached at some point,” and the Treasury market’s selloff on Thursday was a response to that view, said William Larkin, portfolio manager with Cabot Money Management in Salem, Massachusetts. “We are definitely braced for higher inflation,” he said.
By the end of the year, the 10-year Treasury note’s yield could rise to about 5 percent if energy costs stay high, Larkin said.
Record high food and energy costs have stoked much of the inflation fears. Oil prices CLc1 surged to a record above $135 per barrel on Thursday, but later fell below $131 as traders moved to take profits.
Bond prices were also undermined early on Thursday after a surprise decline in weekly U.S. jobless claims data hinted that an anemic labor market may be showing signs of stabilization.
Inflation was the primary theme on Thursday though, with 2-year Treasury notes US2YT=RR trading 8/32 lower in price for a yield of 2.54 percent from 2.41 percent late on Wednesday, while 5-year notes US5YT=RR traded 22/32 lower in price for a yield of 3.23 percent from 3.08 percent. (Additional reporting by John Parry; Editing by James Dalgleish)