U.S. government debt prices fell in quiet trade Tuesday, weighed down by profit-taking and surging stocks, but expectations of a Federal Reserve interest rate cut next week curbed losses.
Traders said the Treasury bond market, which had rallied after Friday's unexpected drop in August nonfarm payrolls, was also hurt by a jump in crude oil prices.
The market remained biased toward a half-percentage-point cut in the benchmark overnight lending rate. Investors were encouraged that Fed chief Ben Bernanke, in a speech in Berlin, said nothing to change expectations that the Fed would cut the rate by a half a point on Sept. 18.
Bernanke, who gave a speech on global imbalances, was silent on the outlook for the U.S. economy and interest rates.
"Assets are being reallocated back into equities, taking a little bit off the table. We have had quite a run on the bond market, so it's not really surprising" that prices should fall, said Kevin Giddis, managing director of fixed income at Morgan Keegan in Memphis, Tenn.
On Monday, Treasuries racked up hefty gains, with some traders betting the Fed would slash the federal funds rate target by half a percentage point to 4.75 percent. Short-dated yields plunged to a two-year low and benchmark 10-year note yields fell to their lowest level since early 2006.
"It's relatively low-volume profit-taking [on Tuesday]," said George Goncalves, chief Treasuries/agencies/TIPS strategist at Morgan Stanley in New York.
"The market is still skewed toward a bigger cut than we are," Goncalves added. "We are thinking 25 basis points."
Fed funds rate futures were pricing in a roughly 70 percent chance of a 50-basis-point cut next week, while the probability of a quarter-point reduction was already fully factored in.
In late New York trade, benchmark 10-year notes were down 11/32 in price for a yield of 4.36 percent, compared with 4.32 percent late on Monday, when they dived as low as 4.30 percent.
Two-year notes fell 5/32 in price to yield 3.94 percent from 3.85 percent late on Monday. Yields, which move inversely to prices, dropped to 3.82 percent on Monday.
Volume was light at around $213.76 billion in the afternoon, below the 20-day moving average of $284.64 billion, according to ICAP.
Rising stocks, encouraged by upbeat outlooks from technology companies and expectations of an interest rate cut next week, eroded some of the government bonds' safe-haven appeal. A surge in oil prices added to the negative tone.
"A little higher oil price, coupled with a few sellers, has been our day. We started weak and we stayed weak," said Morgan Keegan's Giddis.
U.S. crude oil futures settled at the highest level on record, with crude for October delivery ending at $78.23 per barrel, up 74 cents or 1 percent, on the New York Mercantile Exchange.
High oil prices can fan inflationary pressures, which reduce the value of bonds over time.
The 30-year bond surrendered earlier gains, dipping 4/32 in price to yield 4.65 percent, compared with 4.64 percent late on Monday. Five-year notes dropped 11/32 in price to yield 4.06 percent, up from 3.99 percent.
On the derivatives market, 10-year swap spreads widened to 66.25 basis point, versus 65.25 basis points late on Monday.
Two-year spreads rose to 77.75 basis points from 77.25 basis points.