US Treasury debt prices finished lower on Wednesday as the Federal Reserve began a two-day meeting at which policy-makers are expected to raise interest rates. The market anticipates the Fed will raise its benchmark federal funds rate by a quarter percentage point on Thursday, lifting it to 5.25 percent.
Such a rate increase will be the 17th in a two-year long campaign of central bank monetary tightening mainly designed to remove monetary stimulus from a growing economy, ward off inflationary pressures and keep inflation expectations low.
A $14 billion Treasury auction of five-year notes was a feature of the trading session. The sale drew moderate interest - the notes were sold at a high yield of 5.203 and demand was 2.05 times the amount on offer - but saw the lowest indirect bid in three years.
Indirect bidders, which include primary dealers and foreign central banks, took home $2.53 billion, or 18.1 percent of the sale - the lowest since June 2003. That compared with a 23.8 percent average in 2006 and last year's average of 38.1 percent.
While prices were in the minus column throughout the session, a late round of selling augmented those losses. Traders said the late selling was the result of dealers saddled with too much inventory after two- and five-year auctions this week totalling $22.0 billion. Benchmark 10-year notes were down 11/32 in price for a yield of 5.25 percent, versus 5.21 percent late on Tuesday.
"The reality is the market isn't going to find a bottom until we see what the Fed is going to do," said Ted Ake, executive director in charge of bond trading at Mizuho.
Dealers are focused on the FOMC's post-meeting statement for hints the central bank is considering extending its string of rate hikes or leaning toward a pause at the August meeting. Futures currently show the market expects an 86 percent chance the Fed will raise again in August.
"The risk is that the language in the statement is slightly less hawkish," said strategists at BNP Paribas. "A more balanced statement, still with inflation concerns, should lower the probability attached to an August hike and lead to some near-term steepening of the curve."
The two-year/10-year yield spread was marginally steeper at an inverse of 3 basis points, down from 4 basis points on Tuesday and a recent high of 6 basis points.
Going into the FOMC meeting, yields on Treasuries with maturities from two years to 30 years hovered near 5.25 percent, the anticipated federal funds rate after Thursday.
Five-year notes were down 6/32 at a yield of 5.24 percent, up from 5.19 percent, while two-year notes were down 3/32, yielding 5.28 percent, up from 5.24 percent.
Thirty-year bonds were down 22/32 for a yield of 5.29 percent, up from 5.24 percent. Earlier in the day, the Mortgage Bankers Association said US mortgage applications slumped last week as interest rates hit their highest in over four years.
The mortgage applications index, considered a timely gauge of US residential housing demand, fell 6.7 percent to 529.6, lower than analysts had expected and spurred by weakness in both the purchase index and the refinancing index. Borrowing costs on the popular 30-year fixed-rate mortgage averaged 6.86 percent in the latest week, the highest level since April 2002.
"If mortgage rates continue to rise, housing-related activity will drop further and eventually subtract from economic growth," said Steven Wood, economist at Insight Economics in Danville, California.
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