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Treasurys Extend Losses After Weak Auction

Reuters
Tuesday, 22 Jul 2008 | 1:44 PM ET

U.S. Treasury debt prices extended losses Tuesday after a $6 billion auction of reopened 20-year Treasury Inflation Protected Securities garnered soft demand, traders said.

The nominal 30-year Treasury bond fell one full point in price for a yield of 4.68 percent, versus 4.62 percent late on Monday.

Bonds were also hit after a senior Federal Reserve official said rising inflation could force the U.S. central bank to raise interest rates before labor and financial markets recover.

"With the stronger bid in the stock market, your underlying trade is a migration out of safe-haven Treasurys and back into stocks," said David Dietze, chief investment strategist at Point View Financial Services in Summit, N.J.

Bond price direction was set early in the day after warnings from Philadelphia Fed president Charles Plosser that the Fed may have to raise rates sooner rather than later.

"The inflation fear is keeping people away (from bonds), and so you are not going to see the flight to quality," said William Larkin, fixed income portfolio manager at Cabot Money Management in Salem, Mass.

Benchmark 10-year Treasury notes were trading 13/32 lower in price for yield of 4.09 percent from 4.04 percent late Monday, while the 2-year note was trading 6/32 lower for a yield of 2.70 percent from 2.60 percent.

Plosser, who is a voter on the Fed's policy-making committee, said Tuesday that the central bank "will need to reverse course" from recent monetary policy loosening, and that he anticipates "the reversal will need to be started sooner rather than later."

He also emphasized that the current federal funds rate of 2 percent leaves the inflation-adjusted federal funds rate between minus 1 percent and minus 2 percent.

Last week the government said consumer prices in June were up 5 percent, climbing by the biggest amount since 2005. That level of inflation is higher than all yields across the Treasury curve, meaning a negative real return on bonds and effectively eliminating debt's safe-haven appeal.

While investors moved away from bonds, stocks also began the day on a weak note after Wachovia posted an $ 8.9 billion quarterly loss, which shook hopes that the banking sector was stabilizing. Normally such bad news from the financial sector would spur investors to buy government debt in the search for a safer-haven investment.

However equities pared losses later Tuesday morning after crude oil prices fell more than $4 per barrel, which analysts said was expected to be good for the economy rather than alleviating much in the way of inflation fears.

"When people look at companies like Wachovia and the news was so dismal but ultimately the stock is trading up, I think maybe fixed-income investors are saying maybe some of the worst case is already priced into stocks and they are ready to rebound," Point View's Dietze said.

Treasurys had already been lent bearish sentiment by a flood of new debt supply this week. The Treasury Wednesday will auction a record large $31 billion of 2-year notes, and will sell $21 billion of 5-year notes Thursday.

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