* 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 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
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
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
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.