U.S. Treasury debt prices slipped on Friday, capping the worst month for the market in nearly 2-1/2 years, as stronger-than-expected business activity data fanned worries the Federal Reserve might slow its bond purchases later this year.
As prices slid, Treasury yields retested their highest levels in more than 13 months, set two days earlier, even though data signaled inflation remained low due to sluggish growth.
It was unclear whether Treasurys prices have bottomed as investors sharply scaled back their bond holdings on worries that reduced Fed stimulus will cause long-term borrowing costs to rise, marking the beginning of the end of quantitative easing (QE) that the Fed adopted in late 2008.
"It's all about the Fed, and how do we get back to fair value after QE," said Gemma Wright-Casparius, portfolio manager at Vanguard in Malvern, Pennsylvania.
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Traders are now grappling with whether the Fed may end bond purchases on a stronger economy, or if it might also choose to end buybacks as stocks and housing prices surge even if the central bank fails to achieve its objective of lowering the unemployment rate to 6.5 percent.
At his congressional testimony last week, Fed Chairman Ben Bernanke said a decision to pare the Fed's current pace of bond purchases may happen at one of Fed's "next few meetings" if the economy looked set to maintain momentum.
However, U.S. inflation, which is running well under the Fed's target of 2 percent, may complicate the Fed's ability to taper its current $85 billion monthly purchases in Treasurys and mortgage-backed securities, commonly called QE3.
"The thing Bernanke cares about preventing the most is deflation first and severe disinflation second, so I suspect that if inflation readings remain very low it's going to make him want to keep on purchasing at the current pace of $85 billion and not even think about tapering," said Michael Schumacher, head of global rates strategy at UBS in Stamford, Connecticut.
Still most investors and traders were clearly unnerved by the possibility of the Fed tapering earlier than they had expected, which was at least into the end of this year.