Short-maturity U.S. Treasury debt prices slipped Friday as the safe-haven bid faded on a stock market rally driven by falling oil.
Crude slipped below $116 per barrel, hitting the lowest levels since May and alleviating some concerns that consumer activity would ebb further and drag on company earnings. Stocks' jump in response drew flows away from safer assets such as government bonds.
"What we are seeing now is oil off, equities are up and that's dragging Treasury yields up," said T.J. Marta, fixed-income strategist with RBC Capital Markets in New York.
The two-year Treasury note's price was down 2/32 for a yield of 2.47 percent, versus 2.43 percent late Thursday.
Earlier Friday, Treasury prices edged up, buoyed by safe-haven bids due to weak earnings results from Fannie Mae and reports of conflict between Russia and Georgia.
However, gains were capped as traders took profits after the previous session's rally in long bonds, the biggest in four years.
Even though U.S. mortgage finance giant Fannie Mae posted a bigger-than-expected quarterly loss and slashed its dividend, government bonds did not make sustained gains because investors had braced for the possibility of a dismal result, analysts said.
"We saw a little bit of profit taking overnight and then Treasurys managed to gain a little ground after Fannie Mae reported losses," said Kim Rupert, managing director, global fixed-income analysis with Action Economics LLC in San Francisco.
Slight bidding for safe-haven Treasurys also came "in a flight-to-quality type trade" after reports of military action in Georgia, said Rupert.
A top official in Georgia's National Security Council said Friday that Russia had invaded Georgia and the two countries were "very close" to war, if not already at war.
U.S. government bonds held steady after a fairly benign reading of U.S. wage inflation. A report showed non-farm unit labor costs rose 1.3 percent in the second quarter, below economists' consensus forecast for a rise of 1.5 percent.
Overall, longer-maturity government securities were helped by gathering impressions that U.S. economic weakness would extend well into 2009 and prevent the Federal Reserve from embarking on interest rate hikes anytime soon, analysts said.
"The bond market is predicting a much softer economic environment going forward and starting to project into 2009 that the Fed may be out of the way and not raising rates for a while," said William Larkin, portfolio manager with Cabot Money Management in Salem, Mass.
The benchmark 10-year Treasury note's price, which moves inversely to its yield, was unchanged for a yield of 3.93 percent, versus 3.93 percent late Thursday.
Oil's fall helped ignite a major dollar rally, putting the U.S. currency on track for its biggest daily gain in six years against the euro. The dollar's recovery was a talking point among bond strategists. Although it was not a clear directional cue for Treasurys on Friday, longer term, if the perceived risks of a dollar crisis diminish, that could help reinforce demand for U.S. government bonds among foreign investors who hold a big chunk of the market.
The 30-year Treasury bond traded up 4/32 in price for a yield of 4.54 percent, versus 4.55 percent late Thursday.
"Inflation is emanating from commodities and yet commodities are off sharply, which makes it really hard to argue the long bond yield will go higher," said Marta.