Treasury debt prices fell Tuesday after a report showing producer price inflation was accelerating caused bond investors to pare bets for Federal Reserve interest rate cuts.
But a trickle of negative news about the banking sector kept credit market worries near the surface, sent stocks lower and put a floor under safe-haven government bond prices.
Surging costs for energy and food worldwide have pushed headline inflation readings near their highest level in decades and core readings of inflation -- which exclude food and energy prices -- above the central bank's comfort threshold. These trends are especially concerning to holders of longer maturity fixed-income securities, which are particularly vulnerable to inflation.
The 30-year bond's price briefly fell a full point, pushing up its yield above 4.40 percent to two-week highs.
"Right now the inflation bogey man is spooking the Treasury market a bit," said John Spinello, Treasury bond strategist with Jefferies & Co. in New York.
The 2.7 percent year-over-year rise of core U.S. producer prices that exclude food and energy "is still above what the Fed would like to see," Spinello said. "At some point when the credit crisis becomes less damaging the Fed will have to pay more attention to the inflation risk going forward."
The benchmark 10-year Treasury note's price, which moves inversely to its yield, fell 9/32 for a yield of 3.55 percent, from 3.50 percent before the PPI data and versus 3.51 percent late Monday.
In a separate report, the Empire State index of manufacturing activity for New York state surprised to the upside, edging into positive territory and hinting at an outlook that was less dismal than expected for this sector of the economy.
"The PPI and the Empire State reports are definitely negative for bonds," said T.J. Marta, fixed income strategist with Royal Bank of Canada Capital Markets in New York.
"The overall (year-over-year) PPI at 6.9 percent, is among the highest levels since the early 1980s. The ex-food and energy reading of 2.7 percent is among the highest levels since the early 1990s. There are still a lot of inflation pressures there," Marta said.
High energy costs in the March producer prices reading may also filter into a high reading for March headline consumer prices, which could hurt bond prices even more, some analysts said.
Costlier energy is of escalating concern to bond investors, since a sustained rise in food and crude oil costs may stoke rising inflation pressures that sharply erode longer maturity bond prices over time. On Tuesday, US crude oil futures rose to new record highsabove $113 per barrel.
Short maturities responded more closely to the outlook for official interest rate moves.
The 2-year Treasury note's price was down 1/32 for a yield of 1.79 percent, versus 1.75 percent before the PPI data and versus 1.76 percent late Monday.
Short-term interest rate futures showed the implied chance of a deep 50 basis points rate cut at the Fed's policy meeting at the end of April slipped to about 30 percent, from about 42 percent shortly before the PPI data. But a shallower 25 basis point rate cut is still priced in.
"Overall, the inflation picture right now is probably a lot more dire than what the Fed would like to see, so expectations of their cuts are being pulled back," Spinello said.