Treasuries Sink, Bond Drops 1 Pt

A bigger-than-expected rise in April U.S. retail sales caused a sell-off in U.S. Treasuries on Tuesday as the increase bolstered the view of a U.S. economy on the mend and heightened anticipation of rising interest rates.

A second straight day of big gains in U.S. stocks, spurred by the rise in retail sales, sucked the safe-haven bid out of Treasuries, sending the 30-year bond down more than a full point in price and pummeling bond and Eurodollar futures contracts on the Chicago Board of Trade and the Chicago Mercantile Exchange.

"It increases the probability for the Fed (Federal Reserve) to raise rates in August -- and some people might think even sooner," said James Caron, fixed-income strategist at Merrill Lynch, who called the April sales surge "an explosive rise."

The Commerce Department said April retail sales surged 1.2 percent, much faster than the 0.7 percent analysts had expected and far outstripping the meager 0.1 percent growth in March. Excluding automobiles, retail sales grew by 1.0 percent, better than the 0.4 percent economists had expected, and higher than the 0.3 percent growth in March.

"The forces today are really just lined up too strongly against the Treasury market," said Kevin Flanagan, fixed-income strategist at Morgan Stanley.

The data were the first substantial read on how the U.S. consumer is faring in the second quarter, and undermine a view that the economy slowed after a robust first quarter, analysts said.

"Everyone had been premising higher Treasury prices on this notion of a pullback in second quarter growth ... certainly the Treasury market had become fully priced," said Flanagan.

December Eurodollar futures, down about five basis points on the session before the retail sales data were released, extended losses by as much as 23 basis points to a low of 96.750 on the CME, raising expectations of higher interest rates from the Fed by year's end.

"They trashed them," said a CME trader, referring to the sudden drop in Eurodollars just minutes after the report's release. "The market was lower on stocks initially, but this number is a lot higher than expected."

Eurodollars bounced off their session lows by midday to trade 19.5 basis points lower at 96.795, implying at least a 2.75 percent fed funds rate at the end of the year, analysts said. The Fed's overnight bank lending rate is currently 1.75 percent, a four-decade low.

On a six-week upswing until the middle of last week, cash Treasuries have fallen off recent peaks. That has come in part on expectations of better economic data, including consumer spending, which represents two-thirds of the economy.

At 5.31 percent, yields on benchmark 10-year Treasury notes have shot up more than a quarter percentage point from a trough of 5.05 percent struck in early May. They are now within spitting distance of early April peaks.

But some analysts expressed caution that the Fed's rate-setting Federal Open Market Committee is not in any hurry to lift rates any time soon.

"While the consumer continues to spend, business spending, the key to timing the Fed, remains weak. We continue to expect a Fed on hold until the September FOMC," said Drew Matus, senior financial economist at Lehman Brothers.

Consumers did not let up on their spending throughout last year's recession, which was mainly caused by a drop in business fixed investment, which has yet to recover.

Several Fed officials were scheduled to make public remarks on Tuesday, including:

-- New York Fed President William McDonough (a voter on the FOMC), before the Chicago Mercantile Exchange at 1:45 p.m. EDT ;

-- San Francisco Fed President Robert Parry (not a voter) speaks on the regional and national outlook in San Francisco at 4 p.m. EDT.

At 12:40 p.m. EDT, two-year Treasury notes were 8/32 lower at 99-31/32, yielding 3.39 percent. Five-year notes tumbled 16/32 to 98-23/32, yielding 4.66 percent. Benchmark 10-year notes fell 21/32 to 96-20/32, yielding 5.31 percent, and 30-year bonds were down 1-4/32 at 94-14/32 to yield 5.77 percent.

June bond futures were off 1-4/32 at 99-29/32, with support at 99-19/32, a low from April 18. June 10-year note futures were testing the session low of 104-08/32, trading down 24/32 at 104-10/32. Minor support was seen at 104-1/32, followed by 103-21/32 to 103-13/32, said Robert Zukowski, technical analyst at 4CAST Inc.

"We could see a small bounce intra-day, but the bottom line is you sell the uptick and look for the next leg down to these levels," Zukowski said.