U.S. Treasury bonds ended the last trading session of 2013 on a down note as the latest government data on housing and consumers brightened the economic outlook, capping the biggest annual loss for government bonds in five years.
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The benchmark 10-year note's price was down 13/32 at the end of the shortened session at 2 p.m. EST, according to Tradeweb. The note's yield rose to 3.03% after hitting as high as 3.036%, the highest level since July 2011.
The yield, a key reference for long-term interest rates for consumers, banks and companies in the U.S. and abroad, climbed from 1.76% at the end of 2012. That represents the biggest calendar-year increase since 2009, the last time the bond market posted a negative annual return.
When bond yields rise, their prices fall.
"As long as [the] economy continues to move forward, yields are headed a bit higher," said Thomas Roth, executive director in the U.S. government bond trading group at Mitsubishi UFJ Securities (U.S.A.) Inc., in New York. Bond yields should rise "closer to a more fair-market determined level rather than an artificial level driven by the Fed's influence," Mr. Roth said.
U.S. bond markets will be shut Wednesday for the New Year holiday.
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It has been a bruising year for the world's largest sovereign debt market, delivering a loss of 2.6% this year through Monday in total return, according to Barclays.
Growing confidence that the U.S. economy is gathering momentum has dimmed the allure of government bonds, which tend to attract flight to safety demand from investors when the economy or the financial system is under stress. Both the Dow Jones Industrial Average and the Standard & Poor's 500 rallied more than 20% in price this year.
Also denting government-bond demand, the Federal Reserve said it would start scaling back its $85-billion-a-month purchases of Treasurys and mortgage-backed securities in January, the first step to wind down its monetary stimulus for the economy five years after the global financial crisis.
Many analysts, investors and traders believe bond yields will rise in 2014 on a gradual pace as there is little inflation threat. Fed officials have signaled they wouldn't raise short-term interest rates from near zero until at least 2015, which could temper a rise in bond yields, traders and analysts said.
"We don't believe rates will rise rapidly or dramatically," said Russ Koesterich, global chief investment strategist at BlackRock Inc., the world's largest asset-management company with over $4 trillion assets under management. "We would look for an increase of around 0.5% for the 10-year Treasury over the course of 2014."
While higher yields will boost long-term borrowing costs for U.S. consumers and companies, analysts believe a gradual rise in yields won't choke off the economic growth.
The 10-year yield soared about one percentage point between May and June, rising from 1.61% at the start of May, when worries started to surface about a shift in the Fed's bond buying.
Traders said bond investors are now better prepared for higher yields. Wagers on a further rise in bond yields have piled in over the past few months, while bond investors have cashed out of Treasury bond funds and bought riskier fixed-income assets or stocks for better returns.
Through November, U.S. bond funds targeting Treasury debt suffered a net outflow of $40.2 billion in 2013, according to data provider Morningstar Inc. In contrast, funds that invest in low-rated junk bonds issued by U.S. companies have attracted $2.6 billion from investors.
To be sure, bond yields could fall in the new year if U.S. economic growth falters, which could prompt the Fed to take much longer to wind down its bond buying, traders and investors said.
A selloff in stocks, which have persistently hit record high levels in 2013, could also drive investors back to the comfort of Treasury bonds, they said.
In recent weeks, buyers have showed up when the 10-year yield traded around 3%.
"Treasurys have been tied to the whipping post for sure, but behind 3% in [the 10-year note] or to 4% in [the 30-year bond] we see some value and suspect others, especially overseas, will share that view at least to do some toe dipping," said David Ader, head of government bond strategy at CRT Capital Group LLC.