The Treasury 30-year bond broke above the 7% yield level yesterday as worries about inflation led to selling at the long end.
Late in the afternoon, the 30-year bond was off 5/8 point to yield 7.01%. That is the highest closing yield on the long bond in six weeks.
Alan Levenson, a money market economist at UBS Securities, said the bond market had gotten too optimistic about the prospects for further improvement in inflation.
"What you have here is the adjustment to the notion that inflation is likely past its lowest point." Levenson said. "The idea is that the first step in a defensive strategy for a bear market is to get out of the long end."
Traders said yesterday's surge in commodity prices reinforced the inflation fears that came to the forefront last week when the April price indexes posted unexpectedly large increases.
The June gold futures contract on the Comex rose $8 an ounce to $376 yesterday. The Commodity Research Bureau index also jumped, led by precious metals, and closed 1.81 points higher at 210.60.
The inflation worries led to retail selling, especially at the long end, traders said.
"The long end was severely beaten up, especially the 10-year note," a government coupon trader said. "There were sellers of the long end in size."
A bond trader said leftover securities from last week's quarterly refunding auctions were weighing on the long end.
"Who wants to buy bonds in an environment where inflation is creeping up?" the trader said. "People are confused and there's supply to be distributed."
Levenson said technical selling also contributed to the long end's losses once the market broke through a key support level early yesterday afternoon.
Note prices also declined yesterday, but short-term notes held their ground better than the long end.
Traders said the short end benefited from purchases for municipal defeasance deals. There were also reports the Federal Reserve bought short-term notes under the table.
Levenson expects long-term yields to continue to climb. He estimated the 30-year will be yielding 7.20% by the end of June and 7.30% or 7.40% by the end of this year.
Walter Clark, director of financial futures research at Rodman & Renshaw, said long-term prices have eroded in recent weeks on worries about the progress of the deficit reduction package. But the next key information on that front will not come until June, when the Senate starts debating the package, he said.
Meanwhile, Clark expects the long bond to hold around the 7% level. He said the possibility of a tightening in Federal Reserve monetary policy should be a plus for the long end, since many participants think higher short-term rates would slow the already lackluster recovery.
A note trader said that even though the long end posted the biggest loss yesterday, the new three-year notes have lost more ground over the last week.
The 7.01% closing yield on the 30-year is four basis points above the 6.97% average at which the bonds were sold on Thursday, while the 4.46% yield on the three-year is 19 basis points above the 4.27% average at last Tuesday's auction.
There was little market reaction to yesterday morning's report that April housing starts rose 6.7%, to a 1.213 million annual rate.
That increase "was just about what the market was expecting," said Martin Mauro, senior economist at Merrill Lynch & Co.
Mauro said the April report showed the housing industry made a comeback last month from the weather-related decline in March, with the biggest increases in April occurring in the areas hardest hit by the March storm. He predicted the housing sector would continue to improve in the months ahead, thanks to favorable fundamentals.
The bond market also ignored yesterday afternoon's Johnson Redbook report, which showed department store sales during the second week of May were up 1.5% from the same period in April.
Today's economic news is expected to be just as much of a nonevent. The consensus forecast calls for a $7.6 billion merchandise trade deficit in March, up from the $7.2 billion April gap.
Also this afternoon, the Treasury will announce the sizes of next week's two- and five-year note sales. Most economists say the government will leave the auction sizes unchanged at $15.25 billion of two-year notes and $11 billion of five-year notes.
The June bond futures contract closed 21/32 lower, at 109 21/32. in the cash market, the 7 1/8% 30-year bond was 21/32 lower, at 101 9/32-101 11/32, to yield 7.01%.
The 6 1/4% 10-year note fell 13/32, to 100 29/32-100 31/32, to yield 6.11%.
The three-year 41/4% note was down 3/32, at 99 11/32-99 13/32, to yield 4.46%.
Rates on Treasury bills were little changed, with the three-month bill steady at 3.02%. the six-month bill up two basis points at 3.12%, and the year bill unchanged at 3.27%.Treasury Market Yields Prev. Prev. Tuesday Week Month3-Month Bill 3.06 2.93 2.826-Month Bill 3.19 3.06 2.991-Year Bill 3.37 3.20 3.162-Year Note 4.02 3.75 3.733-Year Note 4.46 4.11 4.145-Year Note 5.26 4.99 5.037-Year Note 5.74 5.48 5.4810-Year Note 6.11 5.86 5.8530-Year Bond 7.01 6.80 6.74Source: Cantor, Fitzgerald/Telerate