July 25, 2013 / 7:09 PM / in 5 years

TREASURIES-Prices drop on caution before Fed meeting

* Prices fall, volatility rises on Fed pullback jitters
    * Treasury sells $29 bln 7-yr notes to solid investor demand
    * Fed buys $4.83 bln notes due 2017, 2018

    By Karen Brettell
    NEW YORK, July 25 (Reuters) - U.S. Treasuries prices fell on
Thursday, with investors reluctant to buy bonds before a Federal
Reserve meeting next week that will be scrutinized for signs
over when the U.S. central bank may start paring back its bond
purchase program.
    Bond volatility has picked up this week and yields have
increased to the high end of their recent range on speculation
that the Fed may start to spell out plans to reduce buying. Most
economists and traders expect that the Fed may start tapering in
    "We think that the Fed might give some preparation for
tapering later in the year," said Michael Chang, an interest
rate strategist at Credit Suisse in New York.
    "If they suggest they may be very aggressive we could see a
selloff going much further, but if they word it in a way that
leaves it open ended and that they could increase QE again if
there is a deflation risk then I think the market could digest
it much easier," he said.
    Bonds held at lower levels after the Treasury sold $29
billion in new seven-year notes to solid investor demand, the
final sale in $99 billion in new coupon-bearing supply this
    The bid-to-cover ratio for the notes was 2.54, the lowest
since May 2009 but indirect bidders, which includes fund
managers and some central banks, bought 48.60 percent of the
    "There was pretty decent participation, the dealers didn't
get a large percentage of them," said Tom Tucci, head of
Treasuries trading at CIBC in New York.
    With the supply over, the next catalyst for market moves
will be the Fed's statement next Wednesday at the conclusion of
its two-day meeting. It will be followed on Friday by the
closely watched employment report for July.
    "I think there is a defensive tone going into next week's
Fed meeting and payroll number," said Tucci. "We need some more
information to either generate a big rally or create the next
leg down on the potential tapering of QE."
    Benchmark 10-year notes were last down 8/32 in
price to yield 2.62 percent, up from 2.58 percent late on
Wednesday. The yields have surged from around 1.60 percent at
the beginning of May on concerns over the Fed pulling back, but
they are down from a two-year high of 2.76 percent on July 8.
    The Merrill Lynch MOVE index, which estimates
future volatility of long-term bond yields, also increased to 80
on Wednesday, up from 73 on Monday. The index had been falling
from a high as 118 on July 5 until this week.
    Weakness in German government debt also added some pressure
to Treasuries, as better economic data reduced the safe haven
bid for the bonds.
    Speculation over who may replace Ben Bernanke as Fed
chairman was also seen adding to volatility.
    President Barack Obama has not made a decision on a nominee
to replace Bernanke, who is expected to step down at the end of
his term in January, a person familiar with the process said on
    Former White House economic adviser Larry Summers and Janet
Yellen, the Fed's vice chair since 2010, are seen as the leading
    The Fed bought $4.83 billion of Treasuries maturing between
in 2017 and 2018 on Thursday as part of its ongoing purchase
program. It will buy between $1.25 billion and $1.75 billion in
bonds due 2036 to 2043 on Friday.
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