TREASURIES-Long-dated bond prices rise before Fed announcement
* Fed meeting in focus on signs of reduced bond purchases * Bond volatility picks up before Fed meeting * Low inflation, exit risks seen complicating Fed decision * Trader says Fed may cut purchases as Treasury cuts supply By Karen Brettell NEW YORK, June 19 (Reuters) - Long-dated U.S. Treasuries prices rose on Wednesday as investors awaited the Federal Reserve's announcement at the end of its two-day policy meeting later on Wednesday for signals over when it may begin to pare back its bond purchase program. Anxious investors have awaited further signs from the Fed since Chairman Ben Bernanke on May 22 said the Fed may decide to pare its purchases in the next few meetings if the economic recovery maintains momentum. A Wall Street Journal article last week sought to clarify that the Fed is unlikely to end all of its bond purchases at once and is far from raising interest rates. The story prompted speculation that Bernanke was concerned about bond yields' volatility and was seeking to calm investors' fear about the speed of any changes to Fed policy. "I can't remember a Fed meeting in a long time that has as much weight as this one," said Charles Comiskey, head of Treasuries trading at Bank of Nova Scotia in New York. The Fed statement is due at 2 p.m. (1800 GMT), when it will also issue economic and interest rate projections. It will be followed by a news conference with Bernanke. Investors have fled from bond funds in huge numbers since Bernanke's comments in May, sending yields surging higher and volatility has picked up from several year lows. "He raised the expectations for a potential policy change somewhere in the future, and today's he's faced with the fact that the market has priced in the beginning of such a change," said Tom Tucci, head of Treasuries trading at CIBC in New York. Benchmark 10-year Treasuries were last up 2/32 in price to yield 2.18 percent. The yields have fallen from 2.29 percent last Tuesday, a high of more than 13 months, but remain significantly higher than about 1.60 percent in early May. Volatility measures also rose before the Fed statement. The Merrill Lynch MOVE index, which estimates future volatility of long-term bond yields, increased to 81 on Wednesday from 78.5 on Tuesday. It is just below an 11-month high of 84.7 on Monday of last week, and up from a multi-year low of around 50 at the beginning of May. Many investors see the economy as on a firmer footing that should allow the Fed to reduce the scale of its buying in the coming months. Others have said that they fear that the ongoing purchases have created complacency, risked new asset bubbles and are making it harder for the Fed to manage an exit from the program. "The longer this goes on the harder its going to be to get out," said Comiskey. The Fed's economic projections will be closely scrutinized as so far growth has lagged behind the central bank's expectations. A cut to its projections may signal that tapering is less likely, while leaving them unchanged may show that the Fed is more confident that growth will pick up in the second half of the year. At the same time, an improving U.S. fiscal picture is reducing the amount of debt that the Treasury needs to issue, which may in turn lead the Fed to scale back its purchases in order to maintain the equilibrium of the effect of the buying. "If the Treasury is borrowing less, in theory the Fed doesn't have to buy as much. The first adjustment may just be that, and then the door gets left open if the economy looks stronger," Tucci said. The Treasury will announce the size of next week's planned new issues of two-year, five-year and seven-year notes on Thursday. Low inflation, however, may be a potential wild card to the Fed's strategy as many see Bernanke as unlikely to reduce bond purchases if price pressures continue to fall, and risk turning into deflation. The Consumer Price Index has risen only 1.1 percent in the last year, well below the Fed's 2 percent target, and market inflation expectations have also plunged since Bernanke's comments in May. Inflation expectations as measured by breakevens on five-year Treasuries Inflation-Protected Securities (TIPS) have dropped to 1.87 percent on Wednesday, down from around 2.40 percent in March.
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