US Treasury debt prices fell on Monday, pressured by the sale of $41 billion of government securities this week and investors' jitters the Federal Reserve might sound a stern inflation warning after its meeting ends on Wednesday.
Reflecting these inflation concerns, an auction of inflation-protected securities was well received, helping bonds briefly trim their losses. Volume was light ahead of the Fed's two-day rate-setting meeting this week, with investors' bearish sentiment driving benchmark 10-year note yields to their highest levels since mid-September.
"The Treasury market is concerned about the inflation threat and exactly what the Fed is going to do," said Mary Ann Hurley, senior Treasuries trader in Seattle at brokerage D.A Davidson.
"While everyone is expecting policy to be unchanged on Wednesday, they are looking to see what the accompanying statement says: does it read more hawkish than the last one," Hurley said.
Treasuries pared some losses after an auction of a $7 billion reopening of five-year Treasury Inflation-Protected Securities (TIPS). With more substantial supply to come to market later this week, prices remained down, traders said. The Treasury will auction $20 billion in two-year notes on Tuesday and $14 billion in five-year nominal debt on Thursday.
Short maturities prices slipped ahead of those auctions, strategists said. "Heading into the two-year auction, there is a little nervousness ahead of the Fed," said Scott Brown, chief economist with Raymond James & Associates, St Petersburg, Florida.
"A couple of weeks ago the market was looking for a rate cut either at the end of this year or in the first quarter. The last few weeks have seen that completely priced out of the market by Fed speak and the data," Brown said.
Depending on economic reports and how concerned the Fed's tone sounds about inflation in this week's policy statement, the two-year note's yield could rise above 5 percent, he added.
The two-year note, which responds closely to expectations for Fed interest rate moves, was down 2/32 in price for a yield of 4.92 percent, compared with 4.88 percent late on Friday. Bond yields and prices move inversely.
Worries about core inflation pressures helped demand at Monday's 5-year TIPS auction. After that sale the nominal five-year Treasury note trimmed its price losses, trading down 5/32 in price for a yield of 4.80 percent, versus 4.82 percent just before the sale and compared with 4.77 percent late on Friday.
But as a whole, the US government debt market does not tend to react strongly to sales of reopened inflation-protected securities, traders said. The benchmark 10-year Treasury note traded down 9/32 in price for a yield of 4.83 percent, compared with 4.79 percent on Friday.
In the absence of major economic data, some news reports on Monday prompted players to consider a more hawkish Fed than they previously thought, traders said. The reports suggested the Fed is reluctant to lower interest rates and may even resume raising them in response to an acceleration in price increases, analysts said.
US interest rate futures suggested traders are pricing in an 8 percent chance that the Fed will raise rates by a quarter percentage point at the end of this week's policy meeting on Wednesday.
Just a month ago, traders were speculating whether the Fed would ease rates by year-end to stimulate growth. Wall Street economists still expect that on Wednesday the Fed's policy-making Federal Open Market Committee will hold short-term US interest rates at 5.25 percent for a third consecutive meeting amid signs of slowing growth.