Treasuries rally

US Treasury prices rose on Tuesday on expectations that the Federal Reserve will cling to a near-zero interest rate policy even as it will signal an end to its $600 billion bond program in June. Investors widely anticipate little changed in policy from Fed Chairman Ben Bernanke's news conference at 2:15 pm (1815 GMT) on Wednesday after the US central bank releases its latest statement and economic forecasts at 12:30 pm (1630 GMT).
"People are squaring up ahead of the Fed events tomorrow," said Jeff Given, portfolio manager at Manulife Asset Management in Boston. Solid demand for $35 billion of new two-year debt, part of this week's $99 billion in coupon-bearing supply, also buttressed the bond market, pushing yields to fresh one-month lows.
The bond market continued its recent advance, as benchmark yields fell six out of the past seven sessions on the notion that the Fed will keep rates near zero because the economy still requires policy accommodation. Tuesday's batch of economic data showed lingering fragility in the housing sector and consumer confidence, even as high oil prices have led to concern about inflation and the need for the Fed to take a tougher stand against rising prices.
Given this outlook, investors piled into long-dated Treasuries, a moved that flattened the yield curve to a level not seen since early April. A burst of short-covering in 10-year T-note futures around the time of the two-year note auction also helped push yields lower, according to Duncan Balsbaugh, senior analyst at IFR Markets, a unit of Thomson Reuters. The 30-year Treasury bond jumped 1-5/32 in price. Its yield slipped to 4.39 percent from 4.46 percent, with technical indicators suggesting the issue is overbought.
The gap between two-year and 10-year yields narrowed to 2.70 percentage points, the smallest since April 5, suggesting traders expect growth and inflation to slow in coming months.
The benchmark 10-year note rose 15/32 to yield 3.31 percent, down 3.36 percent from late Monday. On Tuesday, the Fed bought $1.999 billion in Treasuries with maturities ranging from May 15, 2021 to November 15, 2027. The purchase was part of the central bank's second phase of quantitative easing, known as QE2, with the intent to stimulate economic growth and investments in riskier assets.
Wall Street stocks rose 1.0 percent with the S&P 500 touching its highest level since June 2008. But with the increasing likelihood that the Fed will not pledge new money to buy Treasuries, there have been concerns over who will step in the Fed's place as the major buyer of government debt. Since the start of QE2, the Treasury has issued about $180 billion in coupon-bearing debt a month, while the Fed has removed roughly $100 billion in bonds from the open market.
MFC's Given reckoned US banks could ratchet up their Treasury purchases to park their money, as loan growth remains anemic and the yield curve remains relatively steep. He added most bond managers are owning far fewer Treasuries than their benchmarks as they have invested in riskier, higher-yielding corporate debt. If the economy slows more than expected, these investors will likely scramble for Treasuries and sell their corporate holdings.
In the meantime, it is unclear whether this longer-term view and Tuesday's solid two-year debt auction will spur appetite at $35 billion sale of five-year notes on Wednesday. The announcement of the five-year auction results will occur shortly after 11:30 am EDT (1530 GMT), about 1-1/2 hours earlier than the usual time.