Treasury 10-year notes capped the biggest weekly drop in eight months as a report showing the cost of living rose in February added to concern inflation may accelerate as the US economy strengthens.
Derivative traders increased bets the Federal Reserve will lift its target rate for overnight loans a year earlier than Fed Reserve Chairman Ben S. Bernanke's pledge of late 2014 after policymakers raised their assessment of the economy on March 13. The difference in yields between 10-year notes and Treasury Inflation Protected Securities climbed to 2.41 percentage points, the most since August, as investors sought a hedge against rising consumer prices.
"The data is strong enough not to warrant further assistance" from the Fed, said Sean Murphy, a trader in New York at Societe General, one of the 21 primary dealers that trade with the central bank. "I don't think the backdrop is particularly supportive for Treasuries."
The 10-year yield rose two basis points, or 0.02 percentage point, to 2.3 per cent, in New York, according to Bloomberg Bond Trader prices. The 2 per cent note due February 2022 dropped 4/32, or $1.25 cents per $1,000 face amount, to 97 12/32. The yield rose 27 basis points this week, the most since a 32 basis point increase in the period ended July 1.
Treasuries pared losses in late trading as the 14-day relative strength index for 10-year note yields indicated rates wouldn't rise much further. The index was at 72.8. A reading of more than 70 suggests to some traders that rates may be about to reverse direction.
Federal Reserve Bank of Richmond President Jeffrey Lacker said on Friday that the central bank will probably need to raise interest rates next year to contain inflation.
While Fed policymakers refrained at their March 13 meeting from new actions to lower borrowing costs and said the US labour market is gathering strength, they also reiterated a pledge to keep the benchmark interest rate at almost zero through at least late 2014.
Forward markets for overnight index swaps, whose rate shows what traders expect the federal funds effective rate to average over the life of the contract, signal a quarter-percentage advance in approximately the September and October 2013 period. Last month, such an increase in the effective rate wasn't predicted until early 2014. This year the effective rate has averaged 0.15 percentage point below the top end of the target range that the Fed reiterated three days ago.
"In the past few weeks, the market had been thinking the forward-rate structure it had priced in was too flat and had rates generally too low," said Jim Lee, head of short-term markets and futures and options strategy in Stamford, Connecticut, at Royal Bank of Scotland Group Plc's RBS Securities Inc. "There are still people thinking that this move is just beginning. However, it appears to me that it may be overdone."
After the Fed's March 13 statement, a measure of traders' inflation expectations that the central bank uses to help determine monetary policy climbed to 2.56 per cent on March 13 from its 2012-low of 2.37 per cent March 5. The five-year, five-year forward break-even rate, which projects what the pace of price increases may be starting in 2017, hasn't risen above 2.62 per cent this year.