US Treasuries staged a modest recovery on Wednesday but dealers warned gains could be limited ahead of next week's expected interest rate increase from the Federal Reserve.
A preference for longer-dated debt exacerbated a trend that started with Tuesday's inflation-led sell-off: long-term yields continued to fall beneath their short-term counterparts.
Benchmark 10-year notes were up 6/32 and yielding 4.70 percent from 4.73 percent on Tuesday. Two-year notes were flat and offering a 4.74 percent yield.
This renewed inversion of the yield curve was timely, if nothing else because low long-term rates were the primary focus of Fed Chairman Ben Bernanke's closely watched speech earlier this week.
The trend started on Tuesday, when the confluence of Bernanke's optimism on the economy and a sharper-than-expected spike in producer prices outside food and energy forced a massive sell-off in Treasuries.
Interestingly, even as investors recalibrated their near-term rate forecasts, they appeared to be rethinking prospects over the longer haul, analysts said.
"What's striking about the market reaction is that it was only the front of the fed funds futures curve that was affected, with the odds of a May hike rising but with 2007 contracts now inverted," said Christopher Low, chief economist at FTN Financial.
Apart from yield differentials and their meaning, Bernanke's speech also dwelt on the economy's underlying strength, scaring many in the bond market into believing the central bank's rate tightening campaign is unlikely to end next week.
A quarter-percentage point interest rate hike this coming Tuesday is largely built into market perceptions, and most analysts foresee at least one subsequent move as well.
In the absence of relevant economic data, the market was left to languish in a tight band after Tuesday's massive downturn, which was driven in part by an unexpected spike in producer prices outside food and energy.
As for the inverted yield curve and its implications, Bernanke was quick to argue that the phenomenon's historic ability to predict recessions was no longer applicable.
Instead, he offered morsels of an explanation for its existence in the current environment, but left the door open to various policy choices as a response.
As the market pondered what surprises next week's policy statement might bring, five-year notes inched up just 1/32 to yield 4.69 percent. The 30-year bond added 15/32 to yield 4.72 percent from 4.75 percent Tuesday.
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