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U.S. Treasuries Tumble; 10-Year Yields Climb to 22-Month High
Elizabeth Stanton in New York


March 30 (Bloomberg) -- U.S. Treasuries tumbled, pushing 10- year yields to the highest since May 2004, as rising prices of oil and other commodities added to concern inflation will accelerate.

Treasuries are poised for their worst first-quarter performance since 1999, with a drop of about 1 percent through yesterday, according to Merrill Lynch & Co. data. The Federal Reserve cited the potential for higher commodity prices to fuel more broad-based inflation, in its statement this week after it raised interest rates a 15th straight time. More rate boosts may be needed to quell inflation, the statement said.

The Fed's hint at further rate increases ``opens the door for the inflation hobgoblins to come back in,'' said Kevin Barry, who manages about $6 billion as head of U.S. bond investments at Credit Suisse Asset Management in New York. A 10-year note yield above 5.5 percent ``is in sight,'' he said.

The 10-year note yield increased 5 basis points, or 0.05 percentage points, to 4.85 percent at 3:41 p.m. in New York, according to bond broker Cantor Fitzgerald LP. Earlier the yield, which moves inversely to the price, touched 4.88 percent, the highest since 4.9 percent on May 14, 2004. The price of the 4 1/2 percent note maturing in February 2016 fell 3/8, or $3.75 per $1,000 face amount, to 97 1/4.

The 30-year bond's yield rose 5 basis points to 4.89 percent and touched 4.92 percent, the highest in a year. Inflation erodes the purchasing power of bond interest payments and principal.

Commodities Rise

Crude oil futures rose to an eight-week high today, and gasoline touched an almost six-month high. Copper, zinc and platinum rose to records.

Treasury inflation-protected securities, or TIPS, fell less than regular Treasuries. The margin by which 10-year note yields exceed 10-year TIPS yields increased to 2.52 percentage point from 2.5 point. The gap represents the average expected inflation rate over the life of the securities.

``If inflation starts to be a problem, that's the place to be,'' said Margaret Weinblatt, who manages about $2 billion at USAA Investment Management in San Antonio.

Fed policy makers, in announcing their rate increase to 4.75 percent on March 28, said the elevated prices of energy and other commodities may ``add to inflation pressures.''

Inflation Measure

The Fed's preferred measure of core inflation, the price index for personal consumption expenditures excluding food and energy, rose 1.8 percent in January from the same month a year earlier. A Commerce Department report tomorrow is expected to show it rose 1.7 percent in February, according to the median forecasts of economists polled by Bloomberg.

The central bank, which forecasts economic growth and inflation semiannually, in February estimated the core PCE price index would increase 1.75 percent to 2.5 percent this year.

The Commerce Department today revised up that measure of inflation for the fourth quarter, to a 2.4 percent rate, from an earlier estimate of 2.1 percent and a 1.4 percent rate in the third quarter.

Yields on 10- and 30-year bonds rose more than two-year yields, which are more sensitive to changes in the Fed's rate. Since the Fed started raising its target in June 2004, two-year yields have climbed about 2 percentage points while 10-year yields are almost 20 basis points higher.

``The market is searching for that purported buyer that's going to be attracted by higher yield levels,'' said Mitchell Stapley, who oversees $14 billion as chief fixed income officer at Fifth Third Asset Management in Grand Rapids, Michigan.

Two-year yields rose 3 basis points today to 4.83 percent, the highest since February 2001. Two-year yields exceeded 10-year yields for the first time in five years in December, and reached as much as 16 basis points higher on Feb. 23.

`Liquidation'

``We're seeing liquidation of the 30-year sector to jump back into the two-year sector,'' said Sean Murphy, a Treasuries trader at RBC Capital Markets in New York.

Ten-year yields surpassed two-year yields by 2 basis points today.

Interest-rate futures show traders are pricing in a 100 percent chance the Fed will increase its benchmark rate another quarter-percentage point to 5 percent on May 10. The odds of another move to 5.25 percent at the June 29 gathering are 32 percent, up from zero at the start of the week.

There is ``pretty critical support'' for 10-year yields around 4.90 percent, meaning buying there may cap yields, said Robert Gahagan, who oversees $8.5 billion as head of taxable fixed income at American Century Investments in Mountain View, California.

The Tennessee Valley Authority's sale of $1 billion of 50- year bonds yesterday helped depress prices for long-maturity Treasuries, David Ader, head of government bond strategy at RBS Greenwich Capital in Greenwich, Connecticut, wrote in a report today. The firm is one of the 22 primary U.S. government securities dealers that trade with the New York Fed.

About $264 billion of Treasuries were traded today through ICAP Plc, the largest inter-dealer broker, surpassing the three- month average of $247 billion.

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