Steady in Europe as Fed begins policy meeting

LONDON: US Treasuries held steady in Europe on Tuesday after a sharp rally the previous session, supported by fears over the euro zone debt crisis and expectations the Federal Reserve will intervene in the bond market to lower long-term rates.

The Fed begins a two-day policy meeting with markets anticipating the central bank will adopt some form of additional monetary easing, for example by shifting its bond holdings away from shorter-term debt and into longer-term paper, an option dubbed Operation Twist.

Market speculation that the Fed may adopt such a measure has helped longer-end Treasuries outperform short-dated paper in recent weeks, causing the yield curve to flatten. The 10/30s yield curve has flattened around 30 basis points since mid-August to around 125 bps.

"The market is priced for Operation Twist, which all things equal should flatten out the long end of the curve," said Rabobank rate strategist Richard McGuire. "The only question is whether the Treasury co-operate by slanting issuance towards the front end of the curve."

Ten-year Treasury yields were up 2.2 basis points at 1.978 percent, after falling around 10 bps on Monday, with T-note futures down 9/32 at 1310-17/64.

"The market is going to price in more going into the meeting but then will typically sell off. It's buy the rumour, sell the fact," one trader said. "But we may continue to see the curve flatten if they do 200 to 300 billion. That's probably less than the market's expecting but if they do more then there could be more curve flattening near-term."

Safe-haven assets were underpinned by Standard & Poor's cutting its ratings on Italy by one notch and international lenders piling pressure on Greece to intensify its austerity drive to avoid running out of money within weeks.

Copyright Reuters, 2011