NEW YORK (Reuters) - Treasuries prices plunged on Wednesday, sending yields to the highest since October, as the Federal Reserve’s brighter economic outlook and ongoing stock market strength drove an exit from safe-haven U.S. government debt for a second day.
Mostly positive stress test results for the U.S. banking sector, announced by the Fed late Tuesday afternoon, also gave investors confidence to seek higher returns in riskier assets.
An unexpected degree of optimism in the Fed’s policy statement on Tuesday pushed the long end of the Treasury curve through support at 3.25 percent. The 30-year Treasury bond was trading 2-24/32 lower in price to yield 3.41 percent, up from 3.27 percent late Wednesday.
The benchmark 10-year Treasury note was trading 1-10/32 lower in price to yield 2.28 percent, the highest since October 31 and up from 2.13 percent late Tuesday.
Treasury rates have risen on better economic data and improved sentiment, along with the mostly positive results from stress tests of the banking sector, said Tom Chow, senior vice president and portfolio manager at Philadelphia-based Delaware Investments, with $150 billion in assets under management.
Simultaneously, “there’s still abundant cash to be put to work in risk sectors and additional proceeds may come from redeployment from ‘risk-free’ sectors like Treasuries,” he said.
The Fed said that 15 of the 19 banks it tested would have enough capital to protect against losses, even in the event of a severe financial shock. The stress tests give a window into the health of the U.S. banking industry.
On Wall Street, stocks were mostly flat, taking a breather after a five-day advance.
“Equities are getting the message that they are cheap relative to bonds, which is the other side of bonds getting the message that they are extremely expensive,” said Alan Ruskin, head of G10 currency strategy at Deutsche Bank in New York.
Some even argued the Fed could raise interest rates next year, although the Fed has continued to say it would keep its federal funds rate exceptionally low at least through late 2014.
“Our guess is the economy continues to do well and (the Fed will) raise rates sometime early in 2013,” said Chris Rupkey, managing director and chief financial economist at Bank of Tokyo-Mitsubishi UFJ in a note.
Against such a backdrop, the market’s reaction to the Fed “makes sense,” said Jonathan Lewis, chief investment officer at Samson Capital Advisors in New York.
“We’re seeing a bear steepener where shorter maturities are holding in much better than longer ones, because the Fed reiterated that the short end of the curve is safe to be in,” he said, referring to the Fed’s pledge on ultra-low rates.
In contrast, inflation and growth expectations could drive the long end of the curve, Lewis said.
The Fed’s observation that the economy has been expanding and that labor market conditions have improved “reinforced the model for the bond market that better data means good equity market performance; when risk assets like equities perform well, it’s a bear steepener, so sell the long end,” he said.
Despite the selloff, an auction of $13 billion in reopened 30-year bonds on Wednesday was met with near-average demand, as were auctions of $21 billion of reopened 10-year notes on Tuesday and $32 billion of three-year notes on Monday.