Bonds drop as stronger data drives view on Fed tapering

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U.S. Treasurys prices fell on Thursday with benchmark yields rising near two-year highs as encouraging readings on jobs and factory activity supported the view the Federal Reserve will dial back its bond purchases sooner rather than later.

Reports showing jobless claims falling to a 5-1/2-year low last week and growth in manufacturing activity to a two-year peak lifted investor expectations for a possible strong July payrolls report due early Friday.

A monthly rise in hiring in the 200,000 area, analysts say, should keep the Fed on track to start to pare its $85 billion purchases in Treasurys and mortgage-backed securities, perhaps at its September 17-18 meeting.

"The tapering theme is front and center still," said Eric Green, global head of rates and currency research at TD Securities in New York. "The market is priced for a 200,000 increase in payrolls and maybe even a bit more."

The consensus forecast for overall U.S. hiring in July among economists polled by Reuters was 184,000, down from 195,000 in June. The unemployment rate likely dipped to 7.5 percent last month from 7.6 percent.

(Read more: July layoffs drop 4.2%: Challenger)

The economy has managed this level of job growth since spring, even though the pace of expansion was a rather anemic 1.7 percent in the second quarter.

On the open market, benchmark 10-year Treasurys notes fell 1-1/32 in price to yield 2.714 percent, up nearly 12 basis points from late Wednesday. The 10-year yield was about 4 basis points below a near two-year high in early July due to a stronger-than-forecast June payrolls report.

The 30-year bond slid 1-29/32 with a yield of 3.769 percent, up 12.3 basis points from Wednesday. The 30-year yield climbed to 2.793 percent, a 23-month high set last month.

Longer-dated yields were on track for their biggest one-day jump since July 5, when the last payrolls report was released.

On Wall Street, the Standard & Poor's 500 index pierced above 1,700 points for the first time.

Hopes for faster growth in the second half ended a brief respite from worries about less Fed stimulus after the central bank released a policy statement on Wednesday.

The statement lacked details on the timing for reducing bond purchases and emphasized the risk of stubbornly low inflation. Traders initially perceived this to mean the Fed might not scale back stimulus soon after all, leading to a Treasurys rally late Wednesday.

Given the recent evidence of growth and discussions about reduced stimulus, it is unlikely the central bank will back down from tapering, said Craig Dismuke, chief economic strategist at Vining Sparks in Memphis, Tennessee. "The cat is out of bag."

US Treasury yields

US 10-YR
US 30-YR

Losing streak

U.S. Treasurys posted a loss for a third month in a row in July, falling 0.11 percent, according to a total return index compiled by Barclays. July's decline was less than the heavy losses suffered in May and June.

Still, the Barclays Treasurys index fell 2.9 percent during this three-month span, the most since April-June 2004.

The broader U.S. bond market fared better, earning a 0.14 percent return in July, according to Barclays' Aggregate bond index. It was still down 2.31 percent so far this year.

The Treasurys market faces possible selling pressure next week, as the government planned to auction $72 billion in coupon-bearing debt as a part of its August quarterly refunding, although a disappointing July jobs report may rekindle appetite for the upcoming U.S. government debt supply, analysts said.

—By Reuters