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Rising food and energy costs fed inflation worries on Wednesday and spurred losses in the US Treasuries market for a third straight session, with the 30-year bond yield touching its highest since April 2010. Worries that rising prices will erode bond values outweighed safety bids stemming from another day of unrest in Egypt, where supporters and critics of President Hosni Mubarak clashed.
Oil prices jumped above $100 a barrel due partly to the political tension in Egypt, while damaging storms in the United States and Australia helped drive up prices of grains and livestock. Sugar futures jumped to their highest in more than three decades. "We are concerned about the upward trend in interest rates as inflation concerns continue to rise," said Gibson Smith, co-chief investment officer of fixed income at Janus Capital in Denver.
Signs of improving job growth also intensified inflation jitters. ADP reported a stronger-than-forecast 187,000 rise in US private payrolls in January in advance of the government's payrolls report for last month on Friday. Other factors behind the bond sell-off included investors unwinding hedges on their mortgage holdings and dealers selling Treasuries to lock in yields on the bonds they underwrite, analysts said.
Block trades in two-year and five-year CBOT Treasury futures, totalling more than 33,000 contracts, changed hands. In the cash market, the 30-year Treasury bond, the maturity most sensitive to rising inflation risk, was down 17/32 in price to yield 4.64 percent, up from 4.61 percent on Tuesday. It briefly touched 4.66 percent, a level last seen more than nine months ago, according to Tradeweb.
Benchmark 10-year Treasury notes ended down 15/32 in price with a yield of 3.49 percent after testing chart support at 3.50-3.51 percent. The 10-year yield was 3.44 percent late on Tuesday. The break-even rate between regular 10-year notes and 10-year Treasury Inflation-Protected Securities, or TIPS, a gauge of investors' long-term inflation expectations, held steady at 2.35 percentage points.
There has been a tight, positive correlation between the TIPS break-even rate with the Reuters-Jefferies CRB index, a gauge on commodity prices, since last August. In the thin-traded sovereign derivatives market, the five-year cost to protect against a US Treasury default was last quoted at 48.50 basis points, down from 48.98 basis points on Tuesday, according to Markit.
Heightened inflation concerns have caused some traders to reconsider whether the US Federal Reserve would end its super-easy monetary policy sooner than previously thought. The Fed sees inflation benign when food and oil prices are excluded, but central bankers in Europe and Asia have voiced inflation concerns.
Two-year Treasury notes - the coupon issue most sensitive to changes in traders' Fed outlook - ended 4/32 lower in price to yield 0.66 percent, the highest in over three weeks and up from 0.61 percent late Tuesday. Fed fund futures were also trading lower, bringing forward the implied timing of a US central bank interest rate increase. According to the futures, the earliest chance of a rate hike is October 2011. On the supply front, the US Treasury said it will auction $72 billion of notes and bonds next week to meet its quarterly refunding. The announcement had little impact on bond prices, as the size of the refunding was largely as expected, analysts said.

Copyright Reuters, 2011

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