* Yellen now seen as front-runner to be next Fed chief
* U.S. yields fall to lowest levels this month, then rally
* Futures signal traders pushing out timing on rate hike
* U.S.-Russia pact on Syria seen paring safety bids for
By Richard Leong
NEW YORK, Sept 16 U.S. Treasury debt prices rose
on Monday after the withdrawal by Lawrence Summers for
consideration as chairman of the Federal Reserve eased fears of
more aggressive monetary policy tightening if he were to head
the U.S. central bank.
Bond yields fell to their lowest this month, led by that on
the five-year note, which fell as low as 1.55
percent. The interest rate on one-month bills dipped below zero.
The rally faded, however, as investors looked ahead to the
Federal Reserve's announcement on Wednesday after a two-day
policy meeting, when the Fed is seen as likely to announce it
will reduce the size of its bond-purchase program.
The surprise withdrawal on Sunday by Summers, a former
Treasury secretary and former top economic aide to President
Barack Obama, came two days before Fed policymakers meet and
coincided with the fifth anniversary of the collapse of Lehman
Brothers. It was widely perceived as positive for bonds as well
Traders now expect the Fed's vice chair, Janet Yellen, will
be the front-runner to succeed Ben Bernanke, whose term expires
in January. It is expected that Yellen would continue the Fed's
likely slow, cautious approach to reduce its bond-buying
program, which is designed to stimulate the economy.
"Assuming Janet Yellen moves to the fore, it should reduce
uncertainty across markets, increasing the likelihood of
continuity at the Fed and an ultra-smooth transition," said
Robert Tipp, chief investment strategist with Prudential Fixed
Income in New Jersey.
A Yellen-led Fed would also likely mean it will take its
time to raise short-term rates even after it stops buying bonds.
Summers' withdrawal lifted Yellen's perceived chances to
become the Fed's first female leader, but the White House has
not made a decision on its nominee. Other candidates said to be
still in contention for the job include Donald Kohn and Roger
Ferguson, both of whom are former vice chairs of the Fed.
The shift in thinking led to a sharp drop in yields in
short-dated Treasuries, which this month hit their highest since
May 2011, partly on worries over Summers as the next Fed chief.
When Fed policymakers meet this week, Wall Street analysts
anticipate they will decide to start shrinking their monthly $85
billion in buying of Treasuries and mortgage-backed securities.
Given the sluggish U.S. economic recovery, the Federal Open
Market Committee - the Fed's policy-setting group - will likely
opt for a small reduction, economists and traders say.
"A small tapering is in the offing, something in the order
of $10 billion. That's still a lot of stimulus coming to the
economy," said Kevin Giddis, head of fixed income capital
markets with Raymond James in Memphis, Tennessee.
Data Monday on industrial output and regional manufacturing
suggested the recovery could manage with less Fed stimulus.
On Monday, the Fed bought $927 million in Treasuries due
November 2024 to February 2031 under its planned $45 billion of
Treasuries purchases in September. It will buy
between $1.25 billion and $1.75 billion in bonds due 2036 to
2043 on Tuesday.
In the U.S. government bond market, the impact of Summers'
withdrawal was mitigated by a pact between the United States and
Russia to rid Syria of its chemical weapons under international
supervision. Fears over a possible U.S. military strike against
Syria had stoked safe-haven demand for bonds.
The rally also showed signs of exhaustion in the afternoon,
with benchmark 10-year notes erasing most of their earlier price
gains and 30-year bond prices falling.
"For the bond market, it's short-covering with some people
who were caught a bit by surprise with the Summers
announcement," said Raymond James' Giddis.
The benchmark 10-year yield was last up 1/32 to
yield 2.87 percent, after falling as low as 2.79 percent.
Thirty-year bonds fell 20/32 in price to yield 3.87
percent, after falling to 3.78 percent.
Many investors rushed to unwind positions from last week,
after they bought 10- and 30-year debt in last week's auctions
and hedged the purchases with shorter-dated debt.
"A lot of people have flatteners on because they are long
bonds from the auction," said Richard Gilhooly, an interest rate
strategist at TD Securities in New York. "We're not any clearer
as to what's happening; the Fed is still tapering."
The gap between the yields on five-year notes and 30-year
bonds expanded to 223 basis points, from 214 on Friday.
In the futures market, traders dialed back expectations the
Fed will soon move away from its current near-zero interest rate
policy adopted in December 2008.
Federal funds futures implied traders priced in a 55 percent
chance of a rate hike at the end of 2014, down from 68
percent on Friday, according to CME Group's FedWatch, which
calculates traders' view on Fed policy.