US Treasury debt prices fell on Friday as rising consumer price inflation fanned doubts about whether the Federal Reserve would cut interest rates further. The Fed's modest rate cut earlier this week and a plan by global central banks to boost lending among banks have hurt safe haven US Treasury fixed income securities.
Two-year note yields had their biggest weekly jump in more than three years. Bond yields and prices move inversely. Data released on Friday showed US consumer prices in November jumped the most in more than two years, driven by surging energy costs. The jump in the November Consumer Price Index follows the biggest rise in the US Producer Price Index since 1973.
"PPI and CPI are a sort of warning sign," said William Larkin, fixed income portfolio manager with Cabot Money Management, in Salem, Massachusetts. "With bond yields so low, as an investor, you have to be very, very cautious here. CPI is 4.3 percent year over year and the 10-year yield is less than that," Larkin said.
Benchmark 10-year notes were trading 5/32 lower in price for a yield of 4.23 percent compared with 4.21 percent late on Thursday. Although the Fed cut rates on Tuesday in an effort to stave off any adverse effect on economic growth from the global credit crisis, evidence of rising inflation could crimp its ability to cut rates much further.
"The inflation numbers did initially hit bonds hard, but then we came back because equities are lower," said Mary Ann Hurley, vice president of fixed-income trading at D.A. Davidson & Co in Seattle. US government bonds typically rise when stocks fall, as investors move funds into safer, highly rated securities.
The Dow Jones industrial average fell about 0.8 percent to 13,404 points. "This data highlights the huge dilemma the Fed is facing between trying to quell the financial dislocations in the market, easing policy, all the while inflation rates are starting to climb higher," said Kim Rupert, managing director of global fixed income analysis at Action Economics LLC in San Francisco.
Adding to a bearish tone for bonds on Friday was data showing a bigger-than-expected rise in US industrial output in November. Libor, or London interbank offered one-month rates, eased early on Friday, giving a little solace to investors looking for signs that a plan by the Fed and other leading central banks intended to encourage lending among banks might make some headway.
A major market focus on Monday will be the first of the term auctions that form part of this joint plan, a $20 billion operation, the Fed has scheduled. "So far people seem to be thinking that the term auction facility (TAF) is going to lower the risk premium on the spreads between money markets rates and the fed target as we approach the year end," said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ.
But the possibility that the central bank plan, announced after the Fed cut the overnight target lending rate by 25 basis points, will not work pushed stocks lower. Two-year notes were trading 3/32 lower in price for a yield of 3.30 percent from 3.25 percent late on Thursday.
Thirty-year bonds, the maturity most susceptible to rising inflation pressures which erode bond values over time, were 6/32 lower in price for a yield of 4.66 percent. Short maturity US interest rate swap spreads were little changed from late Thursday but sharply narrower than a record wide earlier in the week.
The two year swap spread was 88.50 basis points late on Friday, in from a record wide beyond 106 basis points hit on Tuesday on a surge of risk aversion from investors disappointed by a modest 25 basis points rate cut from the Federal Reserve.
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