Yields drop as risk appetite fades on emerging market worries

NEW YORK: US Treasury yields fell on Wednesday after two straight days of gains as risk appetite soured amid nagging concerns about fallout from the Turkish crisis hitting other emerging markets.

The yield curve also flattened, with the spread between US 2-year and 10-year notes narrowing to 23.2 basis points , the tightest gap since at least March 2010, according to Reuters data. A flatter yield curve reflects market uncertainty.

Stronger-than-expected US economic numbers briefly lifted yields, but they soon hit new session lows as buying of Treasuries resumed.

"Right now, the overall sentiment, especially toward emerging markets, is fragile, and then you have the strong dollar, which is adding to uncertainty," said Keith Lerner, chief market strategist at Suntrust Advisory Services in Atlanta.

While the Turkish lira moved further away from record lows, other emerging market currencies, such as the South African rand and the Mexican peso, faltered.

The lira continued to rally on liquidity measures announced by the Turkish central bank on Tuesday.

A leading emerging market stock index entered into what is commonly regarded as bear territory on Wednesday, down 20 percent since January, as a fresh wave of selling extended a slump.

In afternoon trading, US 10-year yields fell to 2.849 percent, down from Tuesday's 2.895 percent. US 30-year yields slid to 3.022 percent, from 3.062 percent late on Tuesday.

On the front end of the curve, US 2-year yields eased to 2.604 percent from 2.633 percent on Tuesday.

Earlier, yields pared losses after a batch of stronger-than-expected US economic data reinforced expectations of an interest rate hike by the Federal Reserve next month. The data was led by US retail sales, which rose 0.5 percent in July, beating expectations.

Other reports showed US productivity in the second quarter was the strongest in three years, while the New York Fed's business index also overshot the consensus forecast.

"With retail sales still robust and inflationary pressures building, the Fed isn't going to be distracted by volatility in emerging markets and will continue to increase interest rates," said Andrew Hunter, US economist at Capital Economics in London.

That said Fed funds futures are rallying in tandem with Treasuries, on safe-haven flows, analysts said. While a September rate hike has been fully priced in, the chances of a fourth hike this year diminished to around 63 percent on Wednesday, from around 67 percent a week ago, according to CME's FedWatch.