Bonds Move Lower on Inflation Fears, Stock Gains

U.S. Treasurys prices fell Wednesday after U.S. inflation accelerated in June to 5.0 percent year-over-year, well above economists' forecasts.

"Treasurys prices fell because the inflation numbers were higher than expected and put the full-year inflation rate up to 5 percent, which is the high end of what we've seen since the early 1990s," said Gary Thayer, senior economist at Wachovia Securities in St. Louis.

The rise in the consumer price index in June was the biggest year-on-year rise since 1991.

A rise in the core inflation rate, which excludes food and energy prices, showed that the impact of high fuel prices was starting to be felt in the prices of other goods, Thayer said.

Meanwhile, the ability of the Federal Reserve to fight inflation pressures by raising interest rates is complicated by a slow-growth economy and often turbulent lending conditions, analysts said.

The benchmark 10-year Treasury note's price, which moves inversely to its yield, traded down 23/32 while its yield rose to 3.92 percent from 3.83 percent late Tuesday.

"The inflation numbers were really pretty damaging," said John Spinello, chief fixed-income technical strategist at Jefferies & Co. in New York. "The Fed's game plan was that a slow economy would cool inflation and that is not occurring."

Inflation erodes the value of fixed-income instruments like Treasurys over time and thus is especially detrimental to the value of long-dated bonds.

Responding to that, the 30-year bond fell more than two full points in price, its yield rising to 4.59 percent from 4.46 percent Tuesday.

Fed Chairman Redux

Fed Chairman Ben Bernanke delivered the second leg of his semiannual monetary policy testimony on Wednesday, appearing before the House Financial Services Committee and answering questions from members of the committee.

On Tuesday, when Bernanke appeared before a Senate committee, his warnings of risks to growth led investors to cut expectations that the Fed would raise interest rates this year.

The Fed chief told lawmakers that restoring financial market stability was a top priority for the U.S. central bank as a weakening housing market, tighter credit and rising oil prices threaten the economy. He said financial markets and institutions remain under "considerable stress."

Reflecting that stress, the TED spread, or the gap between yields on 3-month overseas dollar deposits and 3-month Treasury bills, expanded to its widest mark since late April for the second consecutive day on Wednesday, reflecting continued concerns about inter-bank lending.

The Treasury curve, or the spread between yields on the 2-year Treasury note and the 10-year note also widened on Wednesday, taking the Treasury curve to its steepest level since early June.

Stock Gains Ease Safety Bid

Stock market gains that eased the safe-haven bid for government securities also put pressure on prices of Treasurys.

All three major stock indexes were all higher shortly before midday with the Nasdaq up more than 1 percent.

Two-year notes, often an obvious beneficiary of the safety bid, were down 1/32 while their yields rose to 2.40 percent from 2.37 percent on Tuesday.

Five-year Treasury notes were down 8/32 in price, their yields rising to 3.15 percent from 3.10 percent on Tuesday when five-year note prices rose 11/32.