U.S. Government Bond Prices Pull Back

Prices of U.S. government bonds pulled back Monday, with the yield on the two-year Treasury note closing at the highest level in almost three months and approaching its 2017 peak, as the Federal Reserve is expected to raise short-term interest rates later this week.

The Fed is scheduled to announce its rate policy decision Wednesday afternoon, followed by Fed Chairwoman Janet Yellen's press conference.

Higher interest rates from the Fed tighten money supply for the broader economy and tend to shrink the value of outstanding government bonds. Yields on short-term Treasurys are highly sensitive to the Fed's rate policy outlook.

The yield on the two-year Treasury note settled at 1.359%, compared with 1.338% Friday. Yields rise as bond prices fall. It was the yield's highest close since March 14 when the yield settled at 1.380%, the highest close since June 8, 2009.

Hectic new debt sales also weighed down bond prices. The Treasury sold more than $100 billion new debt Monday via four offerings with maturities spanning from three months out to 10 years. A $12 billion sale of 30-year bonds along with a four-week bill auction are due Tuesday.

The yield on the benchmark 10-year Treasury note closed at 2.215%, compared with 2.201% Friday.

The Fed is widely expected to raise rates again after doing so last December and in March. For bond investors, the key question is what the Fed would do beyond June along with any update on its plan to start unwinding a balance sheet that includes more than $2 trillion worth of Treasury bonds.

The 10-year Treasury yield has fallen from this year's peak -- slightly above 2.6% in March. Signs of slowing inflation in recent months have bolstered some investors' expectations that the June hike may be the last one this year. The yield settled at 2.147% on June 6, the lowest level since November.

The view of a slowly-moving Fed boosted demand for the $24 billion sale of three-year notes earlier Monday to the highest since December 2015. The highlight was 65.6% indirect bidding, a proxy for foreign demand, which was the highest since a record high of 68.6% in Nov 2009.

"The market continues to price in a lower trajectory of rate hikes than the path predicted by the Fed in prior meetings," said Michael Lorizio senior trader at Manulife Asset Management.

Robust demand for haven bonds also reflects some concerns about the U.S. stock market. Technology shares suffered a selloff Friday and softened Monday. The tech-heavy Nasdaq stock index has outperformed the Dow and S&P 500 index this year, fueling some concerns whether valuation is getting stretched. For some investors, buying Treasurys offers some protection if stocks suffer a larger downturn.

The strong three-year sale pushed down the 10-year Treasury yield to 2.187%, but the yield rose after the 10-year Treasury auction. Overall demand was solid and the indirect bidding of 66.1% was the highest since January. Yet the auction was sold at a yield of 2.195%, slightly higher than what it traded right before the auction. That means demand was softer than bond dealers had anticipated, which prompted some to sell bonds to book profit.

The risk for bond investors is that the Fed doesn't make big adjustments to their rate policy projections despite slowing inflation, which may disappoint investors looking for a more dovish tone, said Jeffery Elswick, director of fixed income and portfolio manager at Frost Investment Advisors LLC.

Mr. Elswick said he expects the 10-year Treasury yield to rise to 2.5%-2.6% at the end of this year, driven by the Fed's reduction of its balance sheet.

Matt Freund, co-chief investment officer and head of fixed-income strategies at asset manager Calamos Investments, said a slowly-moving Fed reduces the risk of a big rise in Treasury bond yields.

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

June 12, 2017 16:03 ET (20:03 GMT)