US Treasuries prices sagged on Wednesday after the Federal Reserve gave a lukewarm grade to the economy, a view that some traders see as overly pessimistic. The Fed's latest assessment came in the wake of a government report that showed new-home sales rising to an eight-month high in December and recent data signalling a pick-up in economic activity.
"The market is not willing to buy into the Fed's vision," said Jim Vogel, interest rate strategist at FTN Financial in Memphis, Tennessee. While the Fed does not reckon inflation as a threat, recent signs of faster growth have bolstered the case for higher inflation occurring sooner than previously thought. This has also increased the allure of stocks and other risky assets and diminished the appeal of cash and bonds, analysts said.
"If the world becomes a better place, I think unequivocally you will get a larger allocation into stocks from fixed income," said Mark Wisniewski, portfolio manager at Gluskin Sheff in Toronto. Benchmark 10-year Treasury notes fell 25/32 in price for a yield of 3.43 percent, up almost 10 basis points on the day. The 10-year yield remained within its recent range between 3.25 percent and 3.50 percent so far this year.
Wednesday's bond sell-off reflected "a punishing belief that there is not enough evidence to risk putting money in longer-dated Treasuries," FTN's Vogel said. Short-dated issues fared better than their longer-dated counterparts after the Fed reiterated its pledge to hold short-term interest rates near zero and to complete its $600 billion commitment to buy Treasuries into the end of June.
Earlier, the bond market pared losses briefly after data showing decent demand for $35 billion of new five-year notes, which precedes Thursday's $29 billion sale of seven-year notes.
While bonds stumbled, Wall Street stocks firmed in late trading with the S&P 500 index closing at a 29-month high. Bonds erased the prior day's gains, fuelled by news that US President Barack Obama's proposed to freeze some federal spending for five years in an effort to begin reducing the mammoth $1.5 trillion US budget deficit. But the optimism for such a plan cooled after Obama delivered it in his State of the Union address. Analysts and traders concluded a proposed freeze was largely symbolic, rather than being a material start on slashing a $14 trillion federal debt load.
Also, the Congressional Budget Office raised its forecast for the US budget deficit this year by nearly 40 percent over prior forecasts to $1.48 trillion. The upward revision stemmed mostly from the mammoth tax-cut package brokered by Obama and top Republican lawmakers last month. Credit rating agencies have recently warned if the US fails to improve its fiscal situation, it will endanger its AAA credit rating. This could dramatically increase US borrowing costs and undermine the safehaven status of its currency and debt.
In the thinly-traded sovereign credit default swap market, the five-year cost to insure against a US default was last quoted at 51.70 basis points, the highest closing level in more than 11 months. This was up from 49.29 basis points at Tuesday's close, according to Markit.