The U.S. Treasury debt market eked out gains Tuesday, as bond bulls brushed off a recovery in equities and focused on signs of a slowing economy and prospects of the Federal Reserve cutting interest rates.
Traders added U.S. government debt holdings in anticipation of weak home sales data in the next couple of days, which would reinforce expectations of lower interest rates in the coming months, analysts said.
The likelihood of more rate cuts resulted in short-maturity Treasuries outperforming their long-dated counterparts and a "bull steepening" of the yield curve, they said.
"This seems to be positioning ahead of the housing and durable goods data. If the data come in weak, they should lead investors to expect more rate cuts, which could be inflationary in the long run," said Michael Pond, Treasury strategist at Barclays Capital in New York.
Two-year Treasury notes, which are sensitive to expectations on Fed policy, were up 2/32 higher in price for a 3.84 percent yield, down from 3.86 percent late Monday.
Benchmark 10-year notes, which fluctuate with traders' inflation outlook, were flat in price for a 4.41 percent yield, down 1 basis point from late Monday.
The two- to 10-year part of the yield curve steepened to 59 basis points from 54 basis points.
Bonds Hold Ground
Treasury prices posted slim gains despite stocks rising for a second day after Friday's massive sell-off. The major U.S. stock indexes advanced, led by the Nasdaq, which gained 1.65 percent. In recent sessions, bonds had moved in opposite direction with stocks.
However, weakness in financial and retail shares suggested that investors remain nervous that the U.S. economy faces further risks from the banking and consumer sectors, due to the housing and credit turmoil.
The likelihood of slowing U.S. growth, which the Fed would combat with rate cuts, would drive down Treasury yields and steepen the yield curve further, investors said.
"We expect modestly lower rates going forward with a steepening yield curve. The Fed is likely not done with easing rates," said James Grabovac, senior portfolio manager at McDonnell Investment Management in Chicago.
U.S. interest rate futures implied that traders are pricing in a 92 percent chance that the Fed will lower rates at the end of its two-day policy meeting next week, up from 90 percent at Monday's close.
On the supply front, the Treasury Department will sell $20 billion in two-year notes Wednesday after tepid investor reception of a $6 billion reopening of five-year Treasury Inflation-Protected Securities Tuesday. It will auction $13 billion in new five-year debt Thursday.
In other cash trading, five-year notes rose 4/32 in price for a 4.05 percent yield, down 4 basis points from late Monday, but the 30-year bond fell 7/32 to yield 4.69 percent, up 1 basis point from late Monday.
In the derivatives market, U.S. interest rate swaps were 0.75 basis points to 1.25 basis points tighter than Monday on stronger stock and credit appetite.