Long-dated US Treasury debt prices fell for the third consecutive day on Wednesday, with record high commodity prices sparking fears about inflation at a time when the economy is deteriorating.
Oil rose above $104 a barrel, gold approached $1,000 an ounce and the US dollar tumbled to a record low against the euro, sending shudders through bond dealers who sold off maturities of five years and more, despite data showing the service sector contracted for a second straight month in February.
Expectations for aggressive action by the Federal Reserve to jump start growth were pared back, with dealers beginning to think price pressures may cause policy-makers to think twice about effectively flooding the market with cheap money.
"The Fed is basically allowing inflation concerns to take a back seat to growth. But at some point - and that point is going to come before the maturities of these long-term bonds - we're basically setting ourselves up for an inflation problem," said William Larkin, fixed income portfolio manager with Cabot Money Management in Salem, Massachusetts.
The price on the benchmark 10-year Treasury note was down 17/32 for a yield of 3.70 percent, up from 3.63 percent late Tuesday. The 10-year yield is well off the 4-1/2-year low of around 3.3 percent hit in January.
Five-year notes slipped 5/32 for a yield of 2.59 percent, up from 2.56 percent on Tuesday. The two-year note's price was unchanged on the day for a 1.67 percent yield. Two-year yields fell to a four-year low of 1.50 percent on Tuesday.
The spread of the 10-year yield over the 2-year widened briefly to 205 basis points, the most since June 2004. The so-called yield curve between the 2-year and 10-year has steepened more than 100 basis points so far this year. The 2-year to 30-year yield curve reached 294 basis points, closing in on the psychologically important 300 level.
Many analysts and dealers expect more to come given inflation fears, which are hitting longer-maturity bonds, while expectations for more Fed rate cuts continue to support shorter-term maturities.
"With so much money being pumped into the market to try to stave off the recession, we may have inflation showing its ugly head in the future," said Albert Safdie, global fixed income trader with Hapoalim Securities in New York.
Adding to pressure on the long end on Wednesday, the breakeven spread of 10-year Treasury Inflation Protected Securities (TIPS), a key gauge of expectations of future price pressures, blew out to the widest since August 2006.
Traders were less confident about the chances of the Fed cutting the federal funds target rate by 75 basis points to 2.25 percent this month, following the service sector report from the Institute for Supply Management.