Yields rise from three-month lows before Fed meeting

NEW YORK: US Treasury yields rose from three-month lows on Monday as investors waited on the Federal Reserve's meeting statement on Wednesday for new indications on when the US central bank is likely to begin paring back its unprecedented monetary stimulus.

The Fed is not expected to announce any plans to pare its bond purchases until its August Jackson Hole economic symposium, though it may start dropping hints that it has started to talk about a taper.

Policymakers will also update their economic projections and markets will be focused on whether they upgrade their inflation projections and see a rate hike as likely in 2023.

Treasury yields tumbled last week after data showed a sharp increase in inflation for May, which some analysts interpreted as the market capitulating to the Fed's view that recent price pressures will be temporary.

Subadra Rajappa, head of US rates strategy at Societe Generale, said that the recent move was more likely driven by positioning as investors betting on further yield rises covered their trades.

"This rally in rates seems very counterintuitive. I still haven't found a very strong case besides perhaps the offset of positioning, people are getting out of trades ahead of the FOMC," Rajappa said.

Benchmark 10-year yields rose one basis point on Monday to 1.47%, after falling to a three-month low of 1.43% on Friday. They have dropped from a one-year high of 1.78% in March.

The risk heading into Wednesday's meeting statement is that the Fed could sound more hawkish than markets are currently pricing for, as the economy reopens and inflation posts strong increases, Rajappa said.

"It seems like too much of a lull given the risks associated with a taper communication," she said.

Another key focus at this week's meeting will be whether the Fed raises the interest its pays on excess reserves (IOER) as money market investors struggle with a lack of high-quality short-term assets.

The Fed's reverse repo facility, which offers approved money managers the option to lend money to the Fed overnight in return for Treasury collateral, set a record $548 billion on Friday. Demand is expected to continue to grow as the Treasury continues to pare issuance of Treasury bills.

By raising the IOER the Fed can ease some downward pressure on short-term rates. Borrowing rates in the overnight repurchase agreement market were at one basis point on Monday.

Some analysts say that the Fed is unlikely to make any adjustments unless the fed funds rate falls below 5 basis points, which it has so far held above. The rate was at 6 basis points on Friday.