Bond Yields Near 8-Month High on Fed Policy Concerns

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Yields on benchmark U.S. Treasurys hovered at eight-month highs on Friday on worries the Federal Reserve could pare asset purchases by the end of the year if the economy improves enough.

Benchmark 10-year notes traded near flat after a Thursday selloff, when meeting minutes from the Federal Reserve hinted at growing concerns within the bank about the risks of the stimulus program.

St. Louis Fed President James Bullard added to those concerns on Friday when he said that the Fed could find itself in a position to think about halting its large-scale asset purchases this year if the economy does well in 2013.

"It's not at all surprising to see Treasurys begin to move to a higher rate range to account for that increased risk that (quantitative easing) won't see the end of 2013," said William O'Donnell, head of U.S. Treasury strategy at RBS Securities in Stamford, Connecticut.

Treasurys could see a wider range than that which held from mid-August through the end of last year on increased uncertainty, he said, with higher rates potentially yet to come.

"Without the Fed's support, markets are beginning to harbor some concerns that at some point this year we're going to have to do such things as taking down $13-$16 billion monthly 30-year auctions without any Fed backup," O'Donnell added.

Benchmark 10-year Treasury note were down 1/32 in afternoon trade, with their yields at 1.915 percent. Yields on Friday reached their highest since May.

Ten-year U.S. debt is considered a benchmark for a number of borrowing instruments, including mortgage rates.

Thirty-year bonds pared early losses to trade higher, recovering some ground after a steep slide this week took those yields to eight-month lows, as well. The bonds were trading up 10/32 to yield 3.108 percent on Friday.

Stronger-than-expected data from the Institute for Supply Management also weighed on Treasuries prices. The vast U.S. services sector in December grew at its fastest clip in 10 months, boosted by a rise in new orders, according to the industry report.

But job growth remained tepid, with steady hiring in December still short of levels needed to bite significantly into unemployment rates.

"Far more important for the bond market than the employment numbers was the reminder that just because the Fed will do QE for a long time doesn't mean they will do the same amount of QE," said UBS U.S. chief economist Maury Harris. "Whether the Fed does $85 billion a month in QE, or $45 billion a month, makes a big difference to the bond market."

In December, the Fed announced it would extend its monthly purchases of $40 billion in mortgage securities and also buy $45 billion in Treasurys each month.

But the minutes released on Thursday hinted at unease about further expanding the Fed's $2.9 trillion balance sheet, which it expanded sharply in response to the financial crisis and recession of 2007-2009.

Several (officials) thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet," the minutes said, referring to the narrower group of voting Fed members.

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