Treasuries plunged, giving back gains after the biggest rally in three years, after Citigroup landed a cash injection that soothed some fears over the health of the financial sector.
Abu Dhabi Investment Authority, the world's largest sovereign wealth fund, is purchasing a 4.9 percent stake of Citi through a $7.5 billion issue of preferred stock. It gives the largest U.S. bank fresh capital as it wrestles with credit liquidity issues stemming from a subprime mortgage crisis.
The deal sparked some rare optimism over the ability of banks to cope with the current credit debacle. Still, that relief was tempered by the 11 percent dividend rate Citi must pay Abu Dhabi, topping the average yield on U.S. junk bonds.
The news sent stocks higher, pulling a good chunk of Monday's gains out of the safe-haven government bond market.
"This turnaround, the sell-off in Treasuries and rally in the stock market is due to some good news out of the financial sector given that Citibank is being infused with some capital," said Rudy Narvas, senior analyst at 4Cast in New York.
"It assuaged some fears but the underlying fear is still there -- one infusion of capital is not going to fix things and lending is still relatively tight among banks," Narvas said.
Benchmark 10-year notes were trading 30/32 lower in price for a yield of 3.96 percent from 3.85 percent late Monday. In a strong rally Monday, 10-year yields were pushed down as far as about 3.79 percent, their lowest since early-2004.
"People, if anything, will take profits given the massive moves we've had," said George Goncalves, chief Treasuries, agencies and TIPS strategist at Morgan Stanley in New York.
"I don't think it's necessarily people going against what we've seen lately but actually taking profits. That's what's causing the bond market moves here."
Outside the spark of optimism from the Citi cash injection, there was further bad news on the U.S. housing market that did little to pare bond losses as such grim tales on home sales have become relatively commonplace.
The S&P/Case-Shiller National Home Price Index fell 1.7 percent from June, marking the largest quarterly decline in the index's 21-year history.
According to the index, prices of existing U.S. single-family homes in the third quarter slumped 4.5 percent from a year earlier, matching a record decline from the previous period.
Bonds held at weaker levels even after data showed consumer confidence hit a two-year low this month and manufacturing activity in the U.S. Midwest slipped in October.
Also, Goldman Sachs slashed its target for the expected trough in U.S. benchmark interest rates by a full percentage point, citing an increased probability of recession and the likelihood of a prolonged period of sluggish performance for the economy.
Bond traders were also unmoved from their sell positions by speeches from Federal Reserve Bank of Philadelphia President Charles Plosser and Chicago Fed President Charles Evans.
Two-year notes were trading 10/32 lower in price for a yield of 3.08 percent from 2.91 percent late Monday, while 5-year notes fell 25/32 for a yield of 3.38 percent from 3.21 percent.
Thirty-year bonds were 1-10/32 lower in price for a yield of 4.37 percent from 4.29 percent.