US Treasuries prices dropped on Tuesday, hurt by fears a steep rise in producer prices could cause the Federal Reserve to raise interest rates again next month and as a safe haven bid into US government bonds appeared to abate.
Bond yields posted their biggest daily jump in a month after a government report showed producer prices rose 0.5 percent in June as food prices posted their biggest gain since October 2004.
"The PPI spooked the Treasury market early on and the risks now are that we could get a similar number in the CPI tomorrow that would keep the Fed going" with interest rate hikes, said George Goncalves, treasury and agency trading strategist at Banc of America Securities in New York.
The headline producer prices figure was above market expectations of a 0.3 percent rise, and prices excluding food and energy items rose 0.2 percent, matching expectations. That raised fears among investors of inflationary pressures ahead. The market will now focus on Wednesday's release of June consumer inflation numbers and Fed Chairman Ben Bernanke's testimony to Congress for a clearer picture on the short-term outlook for interest rates and inflation.
Bernanke is scheduled to testify on the Fed's semi-annual monetary policy report before the Senate Banking Committee at 10:00 am EDT (1400 GMT).
"Treasuries are down because of a combination of two things: the safe haven buying that we saw Friday and Monday has really subsided, so we don't have the flight to quality bid we had," said Rick Klingman, head trader on the US Treasury desk with ABN Amro in New York.
"The PPI numbers have really alerted people to the possibility of a bad CPI number and of another Fed tightening in August," Klingman added.
The data raised concerns among investors that the Fed could tighten monetary policy by another 25 basis points at its August 8 meeting, raising the funds rate to 5.5 percent. US short-term interest rate futures showed investors put the chances of a 25 basis points rate rise in August at about 70 percent, up from 57 percent late on Monday. Benchmark 10-year notes traded down 18/32 in price for a yield of 5.14 percent, versus 5.07 percent late on Monday. Bond yields move inversely to their prices.
The two-year note was down 4/32 in price to yield 5.19 percent, versus 5.12 percent late Monday. The 30-year bond was down 30/32 in price for a yield of 5.17 percent, versus 5.10 percent late on Monday. Treasuries' declines were exacerbated by dwindling safe-haven flows inspired by the week-old conflict between the Israeli military and Hizbollah guerrillas in Lebanon. Safe-haven buying contributed to a rally in Treasuries last week. Israeli warplanes battered Lebanon, killing 30 people, and more Hizbollah rockets hit northern Israel, killing one as UN Secretary-General Kofi Annan called for an international force to stabilise southern Lebanon.
Treasuries prices were also depressed by a report showing that foreign central banks sold a net $14.3 billion of Treasuries in May, the largest outflow since August 1998. Strong buying by private investors resulted in an overall net inflow to Treasuries of $13.2 billion in May.
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