Bonds sink on inflation concerns
Treasurys fall after a Fed official says inflation remains a top concern for the U.S. economy.
NEW YORK (CNNMoney.com) -- Treasury prices fell Tuesday as the president of the Philadelphia Federal Reserve said inflation needs to be corrected "sooner rather than later."
The benchmark 10-year note fell 10/32 to 98 12/32 and its yield rose to 4.08%. Bond prices and yields move in opposite directions.
The 2-year note declined 4/32 to 100 13/32 and yielded 2.66%. The 30-year long bond slid 14/32 to 95 20/32, with the yield rising to 4.65%.
Charles Plosser, the Philadelphia Fed president, said the U.S. central bank must boost its key interest rate soon.
"We will need to reverse course - the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later," Plosser said. "I believe it will likely need to begin before either the labor market or the financial markets have completely turned around."
Plosser is a voting member of the rate-setting Federal Open Market Committee.
The Fed has historically raised interest rates to stem the tide of inflation. But last week, Fed chairman Ben Bernanke suggested the poor economic conditions may not support a decision to hike rates in the near future.
Bond investors are typically wary of high inflation, because a declining dollar has the potential to negate the interest they earn on their investment.
"Plosser's comments are certainly not helping," said Michael Cheah, an AIG SunAmerica bond fund manager. "Inflation remains a concern."
Possible addition to bond calendar: The U.S. Treasury Department may bring back either the 3-year note or the 7-year note, or expand the sale of 10-year notes to a monthly event when it reports its next quarterly refunding schedule on July 31, according to a report in The Wall Street Journal.
The Treasury has not sold a 3-year issue since last year, and it eliminated the 7-year note in 1993. Also, currently, the Treasury only auctions new 10-year notes on a quarterly basis.
The Journal said the government needs to raise more money in order to pay off its ever-increasing debt. The economic-stimulus package added to the government's budget deficit, and added support to mortgage financiers Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) would require even more money.
The Bush administration said it expects a budget deficit of $410 billion for fiscal 2008, compared with $163 billion in 2007. But some economists think the deficit could grow to more than $500 billion this year.
"This is a very disturbing trend," said Cheah. "When the government adds more debt by issuing bonds, it's generally bad news - it's just like a highway adding another toll booth."
Financials: Several financial institutions reported hefty losses in the past few weeks, including a $9 billion loss from Wachovia (WB, Fortune 500) Tuesday. Generally, when banks report dour news, investors flock to the perceived safety of the bonds market, but that has not been the case recently.
"This is the because the bond market priced in the greater chance of a government buildup in funds for Fannie Mae or Freddie Mac," said Cheah. "But it would be prudent for the Treasury market to start stepping up, because there's a $7 trillion debt to assume."
Treasury Secretary Henry Paulson urged Congress Tuesday to approve the Bush administration's plan to back up mortgage financiers Fannie Mae and Freddie Mac. Paulson said it's crucial that the companies have access to the capital they need to maintain their operations and regain the public's confidence. 
