US Treasury prices slipped in Friday's short, pre-holiday session, breaking a four-day rally after economic data bolstered dealers anticipation the Federal Reserve will continue with rate increases for much of 2005. Trading will be closed on Monday for the Martin Luther King Jr. Day holiday. Strong industrial production seemed to bolster the case for more rate increases and a bigger-than-expected drop in monthly wholesale prices was not seen as enough to throw the Fed off track.
Futures already factor in rate hike in February, March and May, which would take the fed funds rate to 3.0 percent. Chances of another 25 basis point increase in June rose to about 63 percent on Friday from 56 percent.
"It looks like the economy is still quite healthy and the Fed is probably following the appropriate course. The economy doesn't need low interest rates." said Gary Thayer, chief economist at A. G. Edwards and Sons.
St. Louis Fed President William Poole told Reuters late Thursday that the central bank would not hesitate to depart from its measured rate increases if necessary.
Still, Poole - a renowned inflation hawk - said he saw no sign of wage pressures and that core inflation was "well controlled."
The Fed reported US industrial output up 0.8 percent in December and up 4.1 percent for the whole of 2004. Wall Street had forecast a modest 0.4-percent increase.
Capacity utilisation rose more than expected to 79.2 percent, the highest in almost four years and is edging closer to levels that are seen as inflationary.
"The underlying trend is bad for bonds," said Christopher Low, chief economist at FTN Financial.
The benchmark 10-year Treasury note was down 14/32 to yield 4.22 percent, up from 4.16 percent.
The 30-year bond fell 21/32, yielding 4.73 percent, up from 4.69 percent.
Five-year Treasury notes were down 9/32 to yield 3.71 percent, up from 3.65 percent. Two-year Treasury notes were down 3/32, yielding 3.23 percent.
"Friday's sell-off was mainly about price action. The intermediate sector of the curve could not take out the post-employment report yield lows, encouraging some selling," said Brian Robinson, analyst at 4CAST Ltd.
Curve flattening continues out the outlook for a persistent Fed. The two-year/10-year yield spread has fallen below 100 basis points and could next test 87 basis points.
US producer prices were down 0.7 percent in December, a sharper than expected drop and the biggest in more than 18 months, the Labour Department showed.
The core rate, stripped of food and energy prices, rose by 0.1 percent against a forecast 0.2 percent increase, the smallest increase since April.
"I wouldn't make too much of the soft rise in the core rate. The trend for the core is about +0.2 percent a month, and we think that's going to stay in place," said Ram Bhagavatula, chief economist at Royal Bank of Scotland.
Indeed, producer prices for the year rose a steep 4.1 percent and core prices advanced 2.2 percent, the largest yearly increase since 1998. "We do not believe today's data will keep the Fed from pushing the funds rate to a neutral level somewhere between 4 percent and 5 percent by late this year," said Brian Wesbury, chief economist at Griffin Kubik Stephens & Thompson.