Treasurys move higher ahead of Fed meeting

U.S. Treasurys

U.S. Treasurys traded higher on Tuesday after the government said inflation was tame in November and investors waited for Wednesday's Federal Reserve policy statement.

The Treasury Department auctioned $32 billion in two-year notes at a high yield of 0.345 percent. The bid-to-cover ratio, an indicator of demand, was 3.77. The Treasury will also sell $35 billion in five-year debt; $29 billion in seven-year notes; and $16 billion in five-year Treasury Inflation-Protected Securities later this week.

Benchmark 10-year Treasury notes were up 10/32, their yields at 2.842 percent.

U.S. consumer prices were flat in November, the Labor Department said. The index excluding its more volatile food and energy items rose 0.2 percent.

Traders remained focused on what the Fed will say about its stimulus program on Wednesday when it concludes a two-day policy meeting. Many analysts expect a tapering announcement in the first quarter of next year, but say a move to rein in bond buying this week is not out of the question.

"I put the probability of a tapering in December at 20 percent, January at 40 percent and March at 80 percent," said Thomas di Galoma, co-head of fixed-income rates at ED&F Man Capital in New York.

Recent data showing lower unemployment and improved economic indicators support an argument for the Fed to begin trimming its bond purchases, though a third element—lower inflation than the Fed wants—could prove to be a stumbling block. Fed policymakers worry that meager price increases risk deflation, a phenomenon that tends to slow economic activity.

Over valuation is in bonds, not stock market: Pro

But after analyzing the November consumer price index, Chris Rupkey, managing director and chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York, said, "Net, net inflation is not dead and there is no deflation.

"(The Fed) delayed tapering QE in September due to Washington uncertainty, and now, with Washington hours away from agreeing to fund the federal government for two more years, there is virtually no reason not to taper. We vote yes. Taper. Do it."

(Read more: Fed taper expected sooner: CNBC survey)

A Reuters poll last week showed 32 economists forecast the U.S. central bank would act in March, while 22 said it would scale back its $85 billion monthly bond-buying program in January. Twelve economists expected a tapering announcement this week.

—By Reuters