U.S. Treasury prices plunged Wednesday for a second straight day, pushing benchmark yields to a six-month high, after a deal to extend tax cuts fueled fears of inflation and a swelling budget deficit.
The intense sell-off raised worries over demand at a $21 billion sale of 10-year notes later this session and a $13 billion reopening of a 30-year bond issue Thursday.
"This tax agreement is a disaster for the U.S. fiscal situation," said Howard Simons, strategist at Bianco Research in Chicago.
A proposal to extend the Bush-era tax-cuts is expected to boost U.S. economic growth by as much as 1 percentage point next year. But the long-term cost to the government from falling tax receipts has spooked bond investors and resulted in a disappointing three-year debt auction Tuesday.
Some investors fear such a tax move could result in more bond purchases by the Federal Reserve, which would "monetize" the government's deficit and stoke price inflation.
The Treasurys market was on track for its worst two-day sell-off since September 2008.
The market decline on Tuesday resulted in a paper loss of $61 billion, according to Bank of America Merrill Lynch fixed income indexes.
Despite an intermittent bout of bargain-hunting, the bond market is stuck in negative territory, as it attempts to find stability after breaching a series of key technical supports in recent days.
"I think that the market is going through the process of re-pricing that in. It was already long, and now you have a situation where the market is re-pricing against what the economic outlook is going forward." said Tom Tucci, head of government bond trading at RBC Capital Markets in New York
Given the swiftness and magnitude of the sell-off, analysts were reluctant to predict where the market would bottom.
Benchmark 10-year notes were trading 1-6/32 lower in price for a yield of 3.28 percent, up from 3.14 percent late Tuesday. The benchmark yield has climbed 15 basis points since the close of business Monday.
If the bond market deteriorates further, the 10-year yield could test support in the 3.30 percent to 3.32 percent area, analysts said.
On the other hand, a market rebound could make the 10-year yield test resistance at 3.10 percent, its 200-day moving average.
In the "when-issued" market, traders expected the reopened 10-year note issue for sale later Wednesday to clear at a yield of 3.28 percent. The U.S. Treasury will announce the results on the 10-year auction at 1 p.m. EST.
"You look back and we've seen a couple months of improved economic data, topped off with some fiscal stimulus added on by the tax cut extension. Add a heavy issuance calendar in the final weeks of the year and you get a foolproof recipe for once again repricing the market," said Robert Tipp, chief investment strategist for Prudential Fixed Income in Newark, New Jersey, which has $240 billion in assets under management.
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