US Treasury debt prices slipped on Tuesday after a 5 percent jump in November housing starts suggested the Federal Reserve might extend its string of interest rate hikes.
Traders said continued strength in housing could underpin economic growth into 2006, encouraging the Fed to keep tightening monetary policy to ward off inflation pressures.
"Housing has been one of the strengths of the economy, and today's report was bond-negative," said Mary Ann Hurley, vice president, fixed income trading, at D. A. Davidson & Co in Seattle. The 10-year note fell 6/32 in price for a yield of 4.46 percent, up from 4.44 percent on Monday.
Resistance is expected to a move above 4.50 percent or below 4.417 percent, and Wednesday's thin calendar of economic reports is unlikely to shake prices much, dealers said.
Treasuries volume was similar to Monday's low level and trailed off sharply after midday.
"The combination of pre-Christmas vacations, the close proximity to year-end and the (New York City) transit strike kept activity on the light side," said Brian Robinson, bond strategist at 4CAST Ltd.
November housing starts were an annualised 2.123 million units, the eighth straight month above a 2-million-unit annual rate and the biggest monthly increase since April in percentage terms, the Commerce Department said.
Building permits rose by 2.5 percent after being forecast to fall marginally.
The results caught traders off guard, especially coming on the heels of a drop in the National Association of Home Builders' December index of market sentiment on Monday.
"The uptrend seen for the past year or so in housing seems to be intact," said Kevin Logan, senior economist at Dresdner Kleinwort Wasserstein.
Chances of a March rate hike by the Fed, as measured by short-term rate futures, are up to 62 percent from about 50 percent late last week. Futures suggest a 90 percent chance of a January Fed hike.
Deferred Eurodollar contracts slid on jitters about Fed policy stirred up by the housing starts report.
"Though core inflation remains tame and price pressures have abated, the strength in housing starts and permits threaten to keep the economy chugging along, which could keep the Fed on course for further hikes beyond 4.50 percent or 4.75 percent," said strategists at Action Economics.
The November US core producer price index was milder than expected at a gain of 0.1 percent, helped by a 0.8 percent decline in the price of new cars and light trucks.
Even so, the prices of core intermediate goods rose 0.5 percent and prices of core crude goods were up 5.4 percent, giving bond bears something to chew on.
The US Treasury yield curve is now almost flat, with yields on two-year to 10-year maturities within a few basis points.
The two/10-year spread ended near five basis points. The last time the spread went to zero was December 2000. An inverted two-year/10-year spread often - but not always - signals recession is on the way.
The 30-year bond fell 5/32 for a yield of 4.65 percent, up from 4.64 percent. Five-year Treasury notes fell 5/32 for a yield of 4.40 percent, up from 4.36 percent. Two-year note yields were at 4.41 percent, up from 4.38 percent.
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