Short-term US Treasury yields jumped to their highest level in 18 months on Tuesday after upbeat comments on the economy from Fed Chief Alan Greenspan fanned fears of an early interest rate hike.
While stating that the evidence of economic improvement was more anecdotal than statistical, the Federal Reserve Chairman made it clear to Senate Banking Committee members that he thought the recovery was on an increasingly stronger footing.
In answers to questions, Greenspan said US companies were regaining the power to raise prices and that a long period of concern over the potential for deflation was over. He added that the economy was "clearly coming back."
For a jittery bond market, that was enough to compound worries that the central bank could begin raising interest rates sooner rather than later.
"The market took Greenspan's comments as a signal that a rate hike is on the horizon," said Frank Hsu, director of global fixed income at Fimat.
Some predicted such a shift in policy could come as early as August, particularly in light of recent upswings in both jobs and inflation data.
Greenspan's optimism was enough to send bonds prices sharply lower, with the benchmark 10-year note sliding 19/32 for a yield of 4.47 percent - the highest closing level since September - from 4.40 percent on Monday.
Yields on the two-year note rose as far as 2.18 percent, from 2.04 percent on Monday, its highest reading since October 2002. They closed at 2.17 percent.
Traders feared the worst was yet to come, since Greenspan's broader address on the economy was slated for Wednesday.
Five-year notes fell 16/32 in price, taking yields to 3.53 percent from 3.42 percent on Monday. Thirty-year bonds dropped 22/32 with yields at 5.26 percent.
The market first flinched when the Fed chief made a passing reference to the inevitability of higher rates, saying that US banks were well positioned to handle such an eventuality.
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