TREASURIES-U.S. bonds rally after Summers quits pursuit for Fed chief post
* Yellen now seen as front-runner as next Fed chief
* U.S. yields fall to lowest levels so far in September
* U.S.-Russia pact on Syria seen paring safe-haven bids for bonds
* Futures signal traders pushing out timing on rate hike
NEW YORK, Sept 16 (Reuters) - U.S. Treasuries debt rallied on Monday as news Lawrence Summers withdrew his name for consideration as the Chairman of the Federal Reserve inspired buying from investors who had feared more restrictive policies if he were to head the central bank. Bond yields fell to their lowest levels so far in September with longer-dated maturities gaining nearly 1 point in price. This surprising weekend development on Summers, which came two days before Fed policymakers meet and coincided with the five-year anniversary of the collapse of Lehman Brothers, was widely perceived as positive for bonds as well as stocks.
Traders now expect current Fed Vice Chair Janet Yellen the front-runner to succeed Ben Bernanke, who will likely step down in January. Yellen is expected to continue the Fed's likely slow, cautious approach to reduce its current bond purchase stimulus, known as QE3. "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 the U.S. central bank will take its time to raise short-term rates, even after it halts QE3. This shift in thinking about Fed leadership coincided with the sharp drop in yields in short-dated Treasuries, which earlier this month rose to their highest levels since May 2011, partly on worries over Summers as the next Fed chief. Fed policymakers will meet on Tuesday and Wednesday, when Wall Street analysts anticipate they will decide on shrinking their current monthly $85 billion in purchases of Treasuries and mortgage-backed securities. Given the sluggish pace of the economic recovery, the Federal Open Market Committee, the central bank's policy-setting group, will likely opt for a small reduction in purchases, according to economists and traders. "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. Monday's data on industrial output and regional manufacturing suggested the U.S. economic recovery could manage with less Fed stimulus.
At 11 a.m. (1500 GMT), the Fed will buy $750 million to $1.00 billion in Treasuries due in Nov. 2024 to Feb. 2031, part of its planned $45 billion Treasuries purchases in September. News of Summers' withdrawal for consideration as Fed chairman was mitigated by a pact between the United States and Russia to secure and 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.
It is unclear whether the bond market rally could be sustained heading into the FOMC meeting, traders said. "I don't think it will go much further from here," said Raymond James' Giddis. "For the bond market, it's shortcovering with some people who were caught a bit by surprise with the Summers announcement." On the open market, the yield on two-year Treasury fell about 5 basis points from late Friday to 0.387 percent after hitting 0.375 percent earlier in overseas trading, its lowest in about 2-1/2 weeks. Longer-dated yields fell sharply, too. Benchmark 10-year yield declined almost 10 basis points to 2.792 percent, near its session low and the lowest in two weeks. 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, at the height of global credit crisis that caused the share price of the Reserve Primary Fund to fall below $1, thereby "breaking the buck." The demise of the U.S. money market mutual fund was seen as a watershed moment during the financial crisis that caused the Fed and other central banks to flood the banking system with cash to avert a massive global market collapse. Federal funds futures implied traders priced in a 56 percent chance of the central bank raising rates at the end of 2014 , down from 68 percent on Friday, according to CME Group's FedWatch, which calculates traders' view on Fed policy.