US Treasury debt prices tumbled on Tuesday as a jump in underlying producer inflation and economic optimism from the Federal Reserve Chairman sparked a wave of selling that took on a momentum of its own.
Overall producer prices fell much more than analysts had predicted, but traders were focused on prices excluding food and energy, which are more relevant for monetary policy.
Here, the pickup was more pronounced than many had foreseen and that, along with Fed Chief Ben Bernanke's rather optimistic outlook on the economy, conspired to send bond prices reeling.
Bernanke argued that even an expected decline in the housing sector would not sufficiently hurt consumption to derail the country's solid economic growth.
Sensing such an assessment would mean more interest rate increases, benchmark 10-year notes dropped 15/32 for a yield of 4.72 percent, up from 4.66 percent on Monday.
The selling hit short-term debt even harder, sending two-year notes 5/32 lower for a yield of 4.74 percent, up from 4.66 percent - the biggest one-day spike since last July. The yield curve inverted anew, with spreads between the two maturities once again dipping into negative territory.
Analysts said positioning among investors was even more crucial to explaining the sell-off than fundamental shifts in economic perceptions. "There was a pent-up desire to be short the market that was not implemented ahead of Bernanke because that was seen as a big risk event," said Bernd Wuebben, senior market strategist at BNP Paribas. "Bernanke has, if anything, reinforced that sentiment."
A short position is a bet on a future downturn in the market, and the latest J.P. Morgan client survey held some hints as to why investors sought to take such positions.
In the poll, the proportion of those who said they were short Treasuries fell 7 percentage points to 35 percent, the smallest since October 2005 and a signal to some that the market should correct. Renewed inflation worries only reinforced investors' desire to bet on lower bond prices and higher yields.
US producer prices dropped a surprisingly steep 1.4 percent in February, the biggest pullback in nearly three years, but rising prices elsewhere showed inflation pressures bubbling.
Excluding food and energy, core producer prices rose 0.3 percent last month after a 0.4 percent gain in January, well above estimates for a 0.1 percent gain. Five-year notes lost 11/32 for a yield of 4.70 percent, while the 30-year bond slipped 22/32 in price, while offering a yield of 4.75 percent.