US government debt prices were slightly higher on Tuesday as short-term rates rose after the Federal Reserve held interest rates unchanged after its policy meeting for the first time in over two years.
The Treasury market rose directly after the announcement but then pared gains as investors digested the Federal Open Market Committee's statement released with its decision.
The Fed said that while slower growth should keep inflation pressures in check, incoming economic data that point to higher inflation may force the central bank to raise rates again.
"The Treasury market was probably ahead of itself," said William Sullivan, chief economist with JVB Financial Group in Boca Raton, Florida. "If there still is a threat of a higher fed funds rate, yields are probably too low at this point in time. That explains the subdued reaction to this announcement."
Two-year notes - which are particularly sensitive to Fed interest rate moves - rose 3/32 in price to yield 4.91 percent, compared with about 4.95 percent shortly before the announcement and 4.96 percent late Monday. Yields move in the opposite direction of prices.
Benchmark 10-year Treasury notes were unchanged in price to yield 4.92 percent. The US central bank voted to keep the federal funds rate unchanged at 5.25 percent, pausing a cycle that had taken the rate steadily higher in 17 successive hikes since mid-2004. Richmond Fed President Jeffrey Lacker cast the lone vote against the move. The Fed provided no explanation for his dissent.
Recent indicators have pointed to a downshift in the economy as the housing market has cooled, but various inflation measures have been surprisingly higher in the past month. But in its statement, the Fed said that slowing economic growth should trump prices pressures.
"Inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand," the Fed said.
Looking ahead to the next Fed meeting, US interest rate futures showed about a 30 percent chance that the Fed would raise rates at its September 20 meeting, down from about 85 percent directly before the Fed's decision was announced.
The movement in 30-year bond prices, which are more sensitive to inflation expectations, hinted that the bond market is not completely sold on the Fed's line of logic. The yield on the 30-year Treasury bonds jumped 7 basis points shortly after the Fed's rate decision, suggesting the bond market expects inflation to rise.