Treasury prices fell yesterday when the day's indicators came in on the strong side, supporting the notion that the economy is on the mend.
The bad news for bonds included larger-than-expected increases in both June housing starts and the core rate of June consumer prices.
By late in the day, the 30-year bond was off 1/2 point to yield 8.48%.
Next week's heavy auction schedule may also have weighed on the market, traders said. The Treasury is due to sell year bills and two-year and five-year notes, in addition to the regular weekly bill auction.
June consumer prices rose 0.2%, in line with market expectations, but the core rate, excluding the volatile categories of food and energy, was up 0.4%. Economists had expected only a 0.3% core rate.
A 1% decline in energy prices kept the overall price index in check last month, but big gains in tobacco and tuition costs sent the core rate of inflation higher.
Elias Bikhazi, an economist at Security Pacific National Bank, said the core rate was especially disturbing for bond market participants since it casts doubt on the widespread expectations that inflation will continue to improve in the early stages of the recovery.
Treasury Market Yields
Wednesday Week Month
3-Month Bill 5.75 5.72 5.72
6-Month Bill 6.01 5.93 6.01
1-Year Bill 6.30 6.24 6.31
2-Year Note 6.89 6.91 6.88
3-Year Note 7.30 7.36 7.33
4-Year Note 7.47 7.55 7.56
5-Year Note 7.92 7.97 7.92
7-Year Note 8.16 8.21 8.17
10-Year Note 8.29 8.32 8.31
20-Year Bond 8.49 8.51 8.50
30-Year Bond 8.49 8.50 8.50
Source: Cantor, Fitzgerald/Telerate
The 0.4% gain in June keeps the core rate at a 5% annual pace, its level for the last four months, Mr. Bikhazi said. That contrasts with the Federal Reserve's forecast Tuesday that consumer prices would rise from 3 1/4% to 3 3/4% this year.
"We agree with the consensus that [inflation] is going to come down, but it's going to take some time," Mr. Bikhazi said, adding that special factors, including a sales tax increase in California, are likely to lift the core rate in July and August.
William Sullivan, director of money market research at Dean Witter Reynolds Inc., said tobacco and education costs "aren't necessarily part of the market basket of goods American consumers confront each day."
Still, Mr. Sullivan said, the June price index "clearly suggests that the economy is strong enough that it can at times lead to somewhat higher price pressures than anticipated.
"And the housing sector has retained enough momentum to be a positive force in the economy," he said.
Last month's housing starts rose 5.2% to an annual rate of 1.04 million, when the consensus was for only a 2% increase. It is the first time starts have come in above the 1 million mark since last November.
The report showed starts rose in every part of the country except the West, with single-family starts posting a 3.8% gain and multi-family starts up 17%.
Analysts said the 3.7% increase in building permits was another favorable sign of the economy, since it suggests starts will continue to increase in the months ahead.
Prices fell immediately after the numbers were released, then drifted a little lower through the rest of the session.
Looking on the brigh side, a trader pointed out that the market has not collapsed, thanks to customers' reluctance to sell securities.
The market might also be taking comfort from some economicsts' attempts to explain away the numbers, he said. "A 2.1% rise in tobacco prices doesn't mean inflation is running amuck," he added.
The market showed little reaction yesterday afternoon when the Treasury announced the sizes of next week's note auctions.
The Treasury will sell $12.5 billion of two-years Tuesday and $9.25 billion of five-years Wednesday to raise a total of $12.7 billion in new cash. The issue sizes were unchanged from the amounts sold in June.
Traders said they would not be surprised to see prices move lower ahead of the auctions.
And Today, they said, the market will be vulnerable if the government reports another decline in jobless claims.
Most analysts expect jobless claims to rise, even though the week of July 6 included a holiday. A Bond Buyer survey showed an average forecast of 400,000 new claims, up from 388,000 the previous week.
The September bond future contract closed 3/8 point lower at 93 11/32.
In the cash market, the 30-year 8 1/8% bond was 15/32 lower, at 95 28/32-96, to yield 8.49%.
The 8% 10-year note fell 1/4, to 97 29/32-98 1/32, to yield 8.29%.
The three-year 7% note was down 1/8, at 99 5/32-99 7/32, to yield 7.30%.
In when-issued trading, the two-year note was yielding 6.9% and the five-year note was quoted at 7.95%.
Rates on Treasury bills were higher, with the three-month bill up one basis point at 5.60%, the six-month bill up three basis points at 5.76%, and the year bill three basis points higher at 5.95%.