TREASURIES-Bonds tumble on Fed tightening fears

By Chris Reese

NEW YORK, Oct 9 (Reuters) - U.S. Treasury debt prices sank on Friday after the Federal Reserve said it would not let the current era of easy money get out of hand, raising fears it was closer to hiking interest rates than previously thought.

The comments by Fed Chairman Ben Bernanke on Thursday night caused the biggest bond market sell-off in more than a month, although the weakness follows a fairly impressive eight-week rally.

The Fed's zero interest rate policy has helped drive the dollar to 14-month lows, and a lackluster long-bond auction on Thursday reminded officials that with a weak currency, foreign appetite for U.S. assets has limits.

Bernanke said the U.S. central bank must continue to prop up the economy for an extended period but cannot do so indefinitely for fear of triggering an inflationary surge.

His words reverberated through debt markets, sending benchmark yields to two-week highs.

'He said that eventually when the economy recovers we will remove our accommodative policy, which should not be a surprise but there was a reaction (in Treasuries),' said John Canavan, analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.

Two-year notes fell 5/32 on the day, yielding 0.98 percent versus 0.90 percent at Thursday's close.

Benchmark 10-year notes fell 1-1/32 on the day, yielding 3.38 percent, the highest since Sept. 25, versus Thursday's close of 3.26 percent. The notes were on track for their worst day in over a month.

The 30-year long bond fell 2-7/32 on the day to yield 4.22 percent, pushing last week's five-month low of 3.89 percent further into the distance. The bond was on track for its biggest single-day jump in yields in nearly three months.

Traders were also taking advantage of their last opportunity to sell ahead of a three-day weekend, with the bond market closed on Monday for Columbus Day.

Bernanke's comments were the latest in a series of statements that appear aimed at warning markets not to expect easy monetary conditions to last forever, because of the need to ward off inflation.

The U.S. central bank is not expected to raise interest rates until after unemployment in the United States has peaked at the end of this year, or early in 2010, according to a majority of primary dealers polled by Reuters.

Officials, however, appear to be walking a tightrope, as they have also reiterated that economic stabilization is their first priority.

Indeed, some analysts say monetary tightening remains a long way off, given lingering effects of the worst recession in 70 years and Bernanke's reputation as an expert on the Great Depression of the 1930s.

In the 1930s, the United States had slipped back into recession in 1937-38 after the government started to cut back on emergency programs in the belief that the worst was over.

'The market appears to be overreacting to Bernanke's comments last night about being ready to hike rates when the economy rebounds,' analysts at RBC Capital Markets said in a note.

'While we certainly believe that Bernanke, especially given his academic background studying the Great Depression, will be ready to quickly respond when the time is right, it is premature to believe that time may be imminent.'

(Additional reporting by Burton Frierson; Editing by Chizu Nomiyama) Keywords: MARKETS BONDS ([e-mail]; [phone]; Reuters Messaging: [e-mail]) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.