Bond yields continued their recent ascent Tuesday, putting pressure on stocks after the government sold $24 billion of three-year notes and an economic report showed further improvement in the services sector.

Weak demand for the government's first refunding auction ignited a flurry of selling Tuesday and sparked concern that the five-year and 10-year note sales planned for Wednesday and Thursday, respectively, might also disappoint.

"It's an emotional environment," said Tony Crescenzi, chief bond strategist at Miller Tabak & Co. and contributor to

TheStreet.com's

sister site

RealMoney

. "It sets a bad precedent for the upcoming auctions."

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The government needs to borrow heavily to pay for tax cuts and increased military spending, but the auctions have come at an inopportune time.

Investors have shunned bonds over the past six weeks, as talk about deflation has morphed into fears about inflation following a string of better-than-expected data. Ballooning budget deficits have also taken their toll. The White House estimates the deficit will hit $455 billion in the year ending Sept. 30 and $475 billion in the following year, and some economists have called those predictions conservative. Since hitting a low on July 13, the yield on the 10-year has surged 130 basis points.

On Tuesday, the 10-year note fell 30/32, pushing its yield up to 4.41%. Meanwhile, the current three-year note fell 15/32 to yield 2.27%. "Even people who may see value are steering clear simply because they are nervous," Crescenzi said.

When the Treasury sells $18 billion worth of 10-year notes on Thursday, Crescenzi said there is a chance the bid-to-cover ratio could edge "uncomfortably close to 1:1." In other words, he fears there will only be $1 in bids for every $1 in notes being auctioned. "If that's the case, investors could become nervous that the government will have difficulty financing its spending needs," he said.

Treasuries came under pressure early on Tuesday after the Institute for Supply management said its services index rose to 65.1 in July from 60.6 in the previous month. That was the best reading since the survey began in July 1997, and it beat economists' estimates for a reading of 59. A strong economy often leads to inflation, which eats away at returns on fixed-income securities.

Some analysts worry that higher interest rates will hold back the economic recovery and lure investors away from stocks, which offer lower yields. The

Dow

fell 149 points to 9036 Tuesday while the Nasdaq fell 40 points to 1673.