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Bonds Add to Inflation-Fueled Losses Following Weak Auction

Treasury debt prices slightly extended losses Thursday, with the benchmark yield reaching its highest since late December, after below-average demand in an auction of reopened 10-year Treasury notes.

Following the auction, benchmark 10-year Treasury notes were trading a full point lower in price for a yield of 4.20 percent from 4.08 percent late Wednesday, while 2-year Treasury notes were trading 8/32 lower for a yield of 2.96 percent from 2.82 percent.

In the moments directly following the auction, the 10-year note yield reached 4.22 percent, the loftiest since late December.

The $11 billion 10-year note reopening "was just on the weak side of average," said Lou Brien, market strategist at DRW Trading in Chicago.

Treasury debt prices slid earlier after surprisingly robust U.S. retail sales data and a Federal Reserve official's warning about the need to control inflation accelerated bond market bets for interest rate hikes.

U.S. short term interest rate futures shifted to fully price in a 50 basis point rise in interest rates by October, while the two-year Treasury note's yield rose to near the 3 percent mark, the highest level since early January.

The benchmark 10-year note's yield, which moves inversely to its price, surged to the highest level since late December after the May retail sales report and as global inflation concerns on record food and energy prices take an increasing toll on global bond values.

"The Treasury market can be perceived as breaking down, having reached new highs in yield," said John Spinello, Treasury bond strategist with Jefferies & Co. in New York.

"Concern over the supply is feeding on itself," ahead of the 10-year reopening, Spinello said, adding that the 10-year yield could soon rise to the 4.25 percent to 4.30 percent range.

The biggest blow to Treasurys came from an earlier report showing a higher-than-expected rise in May retail salesof 1.0 percent.

"These retail sales numbers were very strong relative to the consensus and are definitely weighing on the Treasury market," said Carl Lantz, U.S. interest rate strategist with Credit Suisse in New York.

"Treasurys have been under pressure all day. Overnight (out of Europe) we had more bad news on the inflation front and then Plosser was very hawkish," Lantz said.

Philadelphia Federal Reserve President Charles Plosser, speaking on CNBC television, said U.S. monetary policy is supportive of growth right now. "Inflation is on everybody's mind," Plosser said. "We have to take appropriate steps to do something about that."

In recent weeks, global policy-makers have increasingly expressed concern that consumers' inflation expectations are accelerating and that rate increases may be needed to contain those expectations.

"The Fed are trying to do as much as they can with jawboning, without doing anything on the rate side in terms of an increase," said Charlie Smith, chief investment officer of Fort Pitt Capital Group in Greentree, Pa.

The highly inflation-sensitive 30-year Treasury bond fell 1 full point in price for a yield of 4.77 percent.

"The sustained strength of the overseas economy has people worldwide worrying about inflation," said Smith. But the U.S. economy remains in a weakened state.

For that reason, some bond market participants, including Smith, do not believe the Fed will start hiking interest rates during the next few months, even though near-term interest rate futures firmly signal that prospect.

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