By Min Zeng

U.S. Treasury bonds pulled back on Friday, capping the biggest weekly price loss in two months, as comments from a top Federal Reserve official raised anxiety that the central bank could raise interest rates next month.

Fed Vice Chairman Stanley Fischer said Friday the case for a rate increase in September was "pretty strong" and that he could see markets settling down before the central bank's Sept. 16-17 policy meeting. Mr. Fischer cautioned that whether the central bank would act depended on upcoming data. He was speaking on the sidelines of the central bank's annual conference in Jackson Hole, Wyo.

Higher interest rates make newly-minted bonds more attractive to buy, and shrink the value of outstanding bonds. The selling concentrated on short-term Treasury bonds because their yields are highly sensitive to changes in the Fed's policy outlook.

The yield on the two-year Treasury note rose to 0.727% from 0.682% Thursday. It is near the highest level of the year. Yields rise as prices fall.

"The read on his comments is that a Fed hike is more likely in September," said Larry Milstein, head of government and agency trading at R.W. Pressprich & Co. in New York.

The yield on the benchmark 10-year Treasury note was 2.188%, compared with 2.168% Thursday and 2.052% at the end of last week

The 10-year yield plunged below 2% on Monday for the first time since April, but demand for haven debt has since dialed back as some upbeat U.S. data have revived concerns that a rate increase next month remains on the table.

Investors are grappling with dueling factors in the bond market. Volatile trading in riskier assets driven by concerns about China's slowing economy and its stock-market turmoil has stoked investors' desire to preserve capital in cash and Treasury debt. Yet with yields near historically low levels, many fund managers find them unattractive to buy.

Meanwhile, while the Fed could hold off raising rates in September, the U.S. central bank is still moving closer to higher interest rates. Many investors say the Fed may wait longer to act because it takes time for tightening financial conditions from the market turmoil to filter into the real economy.

"This kind of volatility in the markets is exactly what the Fed doesn't want to tighten policy," said Todd Hedtke, a senior money manager at Allianz Investment Management which manages more than $600 billion in assets globally. Mr. Hedtke said he expects the Fed to start raising rates in October, though he says the Fed may wait longer should the financial markets fail to stabilize.

Global uncertainties and contained inflation threats have sent the 10-year Treasury yield lower after hitting this year's peak of 2.5% in June. The yield is a bedrock of global finance and a primary gauge of investors' sentiment toward growth and inflation.

Investors put $1.68 billion net cash in U.S.-based mutual funds and exchange-traded funds targeting the Treasury bond market for the week that ended Wednesday, according to fund tracking company Lipper. It marks the biggest one-week inflow since April. Through Wednesday, the fund group has attracted a net cash inflow of $14.45 billion, on track to be the biggest annual inflow since 2009.

Not everyone is rooting for Treasurys.

Andy Chorlton, head of U.S. multisector fixed income at Schroders Investment Management North America, which has $487.4 billion in assets under management, said he has cut holdings of Treasurys recently and allocated more cash into corporate bonds, which offer more attractive yields, especially following the market turmoil over the past week.

Still, Mr. Chorlton said he won't abandon Treasurys. He still has "meaningful" allocation to U.S. government debt because the market is the most liquid bond market in the world.

"You don't want to spend all of your dry powder" especially with market volatility on the rise, he said.

 
 
COUPON  ISSUE      PRICE      CHANGE   YIELD   CHANGE 
 
5/8%    2-year     99 26/32   dn 2/32  0.727%  +4.0BP 
1%      3-year     99 29/32   dn 5/32  1.032%  +5.3BP 
1 5/8%  5-year     99 9/32    dn 6/32  1.523%  +3.9BP 
2%      7-year     99 24/32   dn 4/32  1.915%  +2.2BP 
2 1/8%  10-year    98 11/32   dn 5/32  2.188%  +1.8BP 
2 1/2%  30-year    99 9/32    dn 6/32  2.911%  +0.9BP 
 
2-10-Yr Yield Spread: +146.1BPS +148.6BPS 
 

Source: Tradeweb/WSJ Market Data Group

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

(END) Dow Jones Newswires

August 28, 2015 16:13 ET (20:13 GMT)