US Treasury prices declined on Tuesday after an upbeat report on manufacturing stoked worries of rising inflation and as investors unwound safe-haven purchases spurred by the political unrest in Egypt. The bond market started the new month lower after a lacklustre January, as more inflation-wary investors sought investments that protect them from rising prices.
Treasury Inflation Protection Securities fared better than regular government bonds for a third straight session. The break-even, or the yield spread, between one-year TIPS and comparable Treasuries grew to their widest since August 2008. In the minds of investors, inflation news outweighed political developments in Egypt where there were widespread calls for President Hosni Mubarak to resign. Investors fear the unrest could destabilise the oil-rich Middle East and possibly disrupt trade via the Suez Canal.
Late Tuesday, Mubarak said he would not leave Egypt, but would step down from office at the end of his term. His speech had no significant market impact. In the United States, the Institute for Supply Management said in its manufacturing sector report on Tuesday that its inflation index rose to 81.5 in January, the highest since July 2008, while the trade group's overall gauge on national manufacturing came in stronger than expected at 60.8, the highest since May 2004.
Robust factory activity is evident world-wide, signalling a pickup in global demand, but it has raised the cost of producing food and manufactured products. The Reuters-Jefferies CRB index, a widely followed gauge on commodity prices, rose 0.1 percent on Tuesday to its highest since October 2008.
Another sign of investors' uneasiness with inflation is the huge gap between short-dated and long-dated yields. The yield curve between two-year and 30-year debt was 400 basis points, one basis point below a record close on Monday. While rising food and oil prices have spooked some investors, the US Federal Reserve seems calm as core US inflation remains tame. This view enables it to keep short-term rates near zero and to complete its $600 billion bond-buying program.
In the thinly traded sovereign derivatives market, the five-year cost to protect against a US Treasury default was last quoted at 49.54 basis points, compared with an 11-month closing high of 51.44 basis points on Friday, according to Markit. Narrower US sovereign spreads are "consistent with improved economic confidence following the surge in ISM and the rebound in domestic equities," said Ian Lyngen, senior government bond strategist at CRT Capital Group in Stamford, Connecticut.
In the cash market, medium-maturity Treasuries were the worst performers, hit by a double-whammy of inflation worries and fears that the Federal Reserve may raise rates earlier than thought. Longer-dated issues fared slightly better. Benchmark 10-year notes were down 12/32 in price to yield 3.42 percent, up from 3.37 percent late Monday, while the 30-year bond was 18/32 lower to yield 4.61 percent from 4.57 percent.
The two-day rise in yields pushed them to the upper end of their recent range. The 30-year yield held at a key technical support at 4.61 percent. Trading volume was higher than usual. It was 25 percent above its five-day average and 5 percent above its 30-day average, according to Tradeweb.
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