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US Treasury debt prices rallied on Thursday after the Federal Reserve raised interest rates as expected and issued a statement that was seen as signalling that it was near the end of its tightening cycle.
Rick Egelton, chief economist at BMO Financial Group, said the statement by the policy-setting Federal Open Market Committee suggested "that we may not be at the end of the tightening cycle but we're pretty close to it." "The bond market's reaction was predictable given that the market was anticipating something a little more hawkish from the Fed," Egelton said.
Jane Caron, chief economic strategist at Dwight Asset Management in Burlington, Vermont, said Treasuries rallied "on the belief that this statement creates a little more scope than the previous statement to allow for a near term pause."
The Fed raised benchmark rates by 25 basis points for a 17th consecutive meeting - taking the federal funds rate to 5.25 percent, the highest since early 2001.
Ten-year Treasury notes, up 8/32 for a yield of 5.21 percent before the Fed issued its statement, were up 12/32 in late trade, yielding 5.20 percent, after the Fed moved.
Chances of another hike in August fell as low as 59 percent on the news, from 81 percent shortly before the end of the meeting of the FOMC, before inching back up to about 65 percent, according to fed funds futures contracts.
Still, William Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida, said that the Fed committee appeared to express heightened concern about the current inflation environment.
"Last time the Fed met it said that some further policy firming may 'yet' be needed to address inflation risks," Sullivan said. "This time it said that 'the extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth.'
"The implication is that the Fed is willing to continue to raise the fed funds target even as economic growth moderates," Sullivan said.
Kurt Karl, chief US economist at Swiss Re in New York, said the Fed's statement left the door open for "another rate hike depending on the economic and inflation data.
US Treasuries rose early, despite a brisk rally in US equities, with the Dow Jones industrial average up more than 100 points at one point before the Fed announcement. Rising stocks often lure investors from bonds.
Blue chip stocks scored their largest single-day gain since April 2005 on Thursday with the Dow up 2 percent. The tech-heavy Nasdaq index soared 3 percent and the S&P 500 stock index rallied 2 percent.
Early buying in Treasuries was tied to revised data on first-quarter economic growth and prices that soothed recent concerns about rising inflation and suggested the FOMC could soon have some breathing room to stop raising interest rates. 30-year bonds were up 15/32 for a yield of 5.25 percent, down from 5.28 percent on Wednesday.
Five-year notes were up 10/32 at a yield of 5.16 percent, down from 5.24 percent. Two-year notes, which are especially sensitive to near-term monetary policy adjustments, rallied, their yield easing to 5.20 percent, down from 5.28 percent on Wednesday. The two-year/10-year yield inversion was nearly erased from a 3-basis-point inversion on Wednesday.

Copyright Reuters, 2006

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