Bond prices tumbled broadly Tuesday as investors shed holdings driven by hopes of a debt deal for Greece and fresh sign of waning deflation threats in the eurozone.
The selloff was led by the eurozone's government bonds, which sent the 10-year yields in Spain and Italy closing above 2% for the first time in 2015. The 10-year bond yields in the U.S. and Germany settled near the highest level of the year. Bond yields rise as their prices fall.
The latest setback raised concerns again for the bond market, which took a heavy beating between late April and mid- May because of worries that bond values are stretched after a strong run-up in prices since the start of 2014.
In late-afternoon trading, the yield on the benchmark 10-year Treasury note was 2.266% compared with 2.19% on Monday and 2.173% at the end of 2014.
The yield's rise since the start of Monday was the biggest two-day increase since July 2013.
The yield on the two-year note rose to 0.659%, the highest closing level since March 17.
Demand for government bonds has been fading after a big rally during the first quarter. Fears over deflation, a toxic cycle of falling consumer prices and reduced spending, have pulled back. Indicators of inflation expectations have ticked up in both the U.S. and Europe as crude oil prices have risen from a six-year low. Inflation is the main threat to bondholders as it chips away bonds' fixed value over time.
Meanwhile, bond prices are getting more volatile as the timing for the Federal Reserve to start raising interest rates draws near, a shift that would shrink the value of outstanding bonds. An upbeat U.S. manufacturing report Monday sent Treasury bond prices lower as it bolstered the case for the central bank to tighten monetary policy for the first time since 2006. Economists expect Friday's key labor-market data to show solid jobs growth in May.
"Another selloff in bonds suggested that investors are finally realizing that inflation is rising and growth will improve," said Luca Paolini, chief strategist at Pictet Asset Management which has $160 billion assets under management.
Sentiment toward Treasury bonds has become the most negative in nine years, according to J.P. Morgan Chase & Co.'s weekly Treasury clients survey released Tuesday.
Investors who expect bond prices to rise accounted for 9% of those polled, down from 11% a week ago. Those expecting bond prices to fall rose to 41% from 24%. The resulting gap of 32% was the biggest since May 2006.
Tuesday's bond market selloff was driven by news reports that officials representing European institutions and the International Monetary Fund on Tuesday morning completed the draft of an agreement to unlock bailout aid for Greece. The deadline for the cash-strapped country to repay loans to the IMF is Friday.
A 0.3% rise in the eurozone's consumer-price index in May added to the bond market's pullback. It was the first rise in inflation in six months, a relief for the European Central Bank that launched a bond-buying program in March to battle deflationary risks. The ECB's next policy meeting is due Wednesday.
New government and corporate bond supply also weighed down bond prices, traders said. Spain sold 10-year bonds Tuesday and France is scheduled to sell bonds later this week.
In Germany, the yield on the 10-year bond yield jumped to 0.707%, the highest closing level since this year's peak pf 0.717% on May 14, according to Tradeweb.
The 10-year yield in Spain settled at 2.072% and the 10-year yield in Italy closed at 2.11%. Both mark the highest closing level since November.
Jeff Given, a portfolio manager who manages $23 billion fixed income asset at Manulife Asset Management, said he expects more price swings in the bond market and that the 10-year yield may rise to the 2.5%-2.6% area at the end of the year.
Mr. Given has been positioned for bond yields to rise since the start of the year by underweighing Treasury bonds and favoring higher-yielding corporate bonds including those sold by lower-rated firms, or junk bonds.
The 10-year Treasury yield dropped below 1.7% at the end of January, but it touched a six-month high of 2.366% during May 12's trading.
So far the pullout of bond funds has been contained. Investors withdrew $2.187 billion cash out of U.S.-based mutual funds and exchange-traded funds targeting the Treasury bond market for the week that ended May 27, according to fund tracking company Lipper.
A week earlier, it was a net inflow of $764 million. This year through May 27, the fund group has attracted a net cash inflow of $7.498 billion.
Despite the rise, U.S. bond yields remain at very low levels. Many investors don't expect bond yields to rise significantly from here as they expect the Fed to be slow in raising rates, given the still moderate pace of economic growth and contained inflation. Higher 10-year Treasury bond yields will push up long-term borrowing costs for U.S. consumers and businesses.
"The key to deciding the pace of the Fed's tightening is long-term sustainability strong economic growth and we haven't seen that," said Patrick Maldari, money manager at Aberdeen Asset Management, which has $490.8 billion global assets under management. "Bond yields are unlikely to spike."
COUPON ISSUE PRICE CHANGE YIELD CHANGE 5/8% 2-year 99 30/32 dn 1/32 0.659% +1.2BP 1% 3-year 99 31/32 dn 2/32 1.005% +2.1BP 1 1/2% 5-year 99 15/32 dn 8/32 1.608% +5.3BP 1 7/8% 7-year 99 4/32 dn 15/32 2.010% +7.3BP 2 1/8% 10-year 98 24/32 dn 22/32 2.266% +7.6BP 2 1/2% 30-year 99 20/32 dn 1 11/32 3.02% +6.8BP2-10-Yr Yield Spread: +160.7xBPS +154.1BPS
Source: Tradeweb/WSJ Market Data Group
Write to Min Zeng at min.zeng@wsj.com -0-
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