US Bond Prices Fall as S&P Drops US Rating Warning

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Prices of U.S. Treasurys slid on Monday, with the 30-year bond yield hitting a 14-month high after a brighter outlook on the U.S. economy from Standard & Poor's prompted investors to dump safe-haven government debt.

S&P raised its outlook on the U.S. rating to stable from negative, meaning the agency is now less likely to cut the world's biggest economy from a current AA-plus.

The news came as traders mulled over bond positions ahead of this week's supply of $66 billion in government debt.

(Read More: S&P to USA: You're Starting to Look Pretty Good)

"There is a general acceptance that the economy is doing better, and on more solid footing, and at the same time that's improving the fiscal situation. The political climate in Washington is also maybe less acrimonious than it was," said Richard Gilhooly, interest rate strategist at TD Securities in New York.

But uncertainty over when the U.S. Federal Reserve could slow its $85-billion-per-month of asset purchases as the economy regains its footing helped limit losses.

Policymakers have signaled they could be looking for the exit— but Fed speakers have yet to point to a consensus on when.

On Monday, for example, St. Louis Fed President James Bullard said inflation remains low enough for the Federal Open Market Committee, the central bank's policy-setting group, to stick with its current bond buying pace.

U.S. core inflation, which excludes volatile food and energy prices, has been running under 2 percent, raising the specter of a similar deflationary spiral as that which crippled Japan for a decade in the 1990s.

(Read More: The Fed's Bond Dealer: This Will Inflict Pain)

"Spot inflation hasn't delivered right now, and people don't know how long the Fed will support the market," said Aaron Kohli, interest rate strategist at BNP Paribas in New York.

This view has pummeled Treasury Inflation-Protected Securities (TIPS), which had thrived under the Fed's current bond purchase program, known as quantitative easing and aimed at reducing unemployment as well as averting deflation.

In light of the recent jitters about the Fed buying fewer bonds, TIPS have looked less appealing to investors since April. The TIPS yields, commonly referred to as "real" yields because they factor out inflation, have jumped.

The 10-year real yield traded above zero percent on Monday, which has not happened since January 2012.

S&P Acknowledges US Improvements

The S&P announcement on the United States surprised traders, as it acknowledged recent financial improvements after a solid if not robust May report on domestic job growth last week. Instead, S&P analyst Nikola Swann said, the agency weighed a gradual slate of improvements in the world's biggest economy.

(Read More: For Some Investors, Federal Reserve Can Start Tapering NOW)

"Although the improvements have been incremental, we thought they had added up," Swann said to Reuters in a phone interview.

On the open market, 10-year Treasury notes last traded 9/32 lower in price with a yield of 2.212 percent from 2.179 percent late on Friday. The 10-year yield came only half a basis point below its 13-month-plus peak of 2.235 percent set in late April.

The 30-year bond was down 14/32 in price, yielding 3.367 percent, from 3.343 percent late on Friday. The 30-year yield rose to 3.382 percent, the highest intraday level since early April 2012, according to Reuters data.

Also on Monday, the Fed bought $1.38 billion in Treasury Inflation-Protected Securities, its latest QE3 purchase.

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