Bonds Sluggish Ahead of Tomorrow's Fed Meeting

The compressing yield spread between shorter maturities and the long bond reflects a growing belief that the FOMC will adopt a bias toward tightening rates at Tuesday's meeting.
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It's the day before a

Federal Open Market Committee

meeting, so the bond market isn't doing anything rash. The market had managed a decent gain in the 30-year Treasury bond this morning, but lately has given back some of it.

Lately the 30-year bond was up 8/32 to trade at 90 27/32. At its highest the bond was up 14/32 to 91 1/32. The yield fell 2 basis points to 5.90. The two-year note, meanwhile, has barely budged, lately down 1/32 to yield 5.31%.

What's notable about this morning, however, is that any gains in Treasuries have been limited to the 30-year bond. Shorter-dated notes are drooping. The compressing yield spread between shorter maturities and the long bond reflects a growing belief that the FOMC will adopt a bias toward tightening rates at tomorrow's meeting.

The 30-year bond, the longest maturity in the Treasury yield curve, reflects inflation expectations, and inflation fears have been on the rise. The two-year note, however, is most sensitive to the fed funds rate. Were the Fed to adopt a tightening bias, it would soothe the market's inflation fears, which is why the 30-year bond is in better shape this morning.

Prior to

Friday, most of the market would have bet that the Fed would not act at tomorrow's meeting. But the 0.7% increase in April's

Consumer Price Index

put the market on a heightened inflation watch, causing a 2-point selloff.

"It's still a minority view, but now it's close to 50%" that the Fed will adopt a bias tomorrow, said Tony Crescenzi, chief fixed income strategist at

Miller Tabak Hirsch

.

A bias toward tightening is essentially a statement telling the market that the Fed is inclined to raise rates at one of the upcoming meetings. The Fed meets eight times a year. After tomorrow's meeting, it won't convene again until the end of June.

Unless the Fed surprises the market and raises interest rates tomorrow, Crescenzi said the bond market's fear of rising inflation will not be allayed possibly for another month, when the next CPI report is released.

"The only way to get rid of inflation fears is with another inflation report," he said.