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Market volatility leaves bonds twisting in the wind

Getty Images. Deflation is everywhere according to this major asset manager.

Treasurys flipped between negative and positive territory on Monday as concerns surrounding global economic growth pushed the 10-year note yield to its lowest level since April and caused volatile swings in U.S. stocks.

Fears of a global market slowdown have caused investors to anxiously question if the Federal Reserve will raise interest rates in September. That initially spurred safe-haven buying of U.S. Treasurys, but demand cooled as stocks pared earlier losses and as markets increasingly priced in the unlikelihood of the Fed boosting interest rates in next month.

Ten-year Treasury note (U.S.:US10Y) yields touched a session low of 1.90 percent, breaching the 2 percent level for the first time since April, but the security recouped most of those losses. It was last down about 2 basis points at 2.02 percent.

Read More Is the euro the new safe haven?

The 10-year yield briefly turned positive, but it fell back into the red after DoubleLine Capital's co-founder Jeffrey Gundlach, told Reuters that the U.S. equity markets would face another round of severe selling pressure.

Major U.S. stock indexes each tumbled about 4 percent. The Dow (Dow Jones Global Indexes: .DJI) closed down 588 points, or 3.6 percent, at 15,871 after falling as much as 1,089 points earlier.

State Street Global Advisors' Michael Arone said the recent stock selloff, "in my perspective, is a natural course adjustment" driven by the unexpected devaluation of China's yuan and the uncertainty of when the Fed will raise rates.

"Once the dust settles, I think U.S. stocks will move higher," Arone said, citing the expectation that second-quarter U.S. GDP will be revised upward later this week and the likelihood that inflation will remain low going forward.

He expects stocks and benchmark Treasury yields to rebound in the third and fourth quarters of this year.

"It wouldn't surprise me if the yield [on the 10-year note] was closer to around 2.5 percent or so as we kind of turn the page on this year to next," Arone said.

"Even if the Fed raises rates at some point this year, which the market is pricing in as less and less likely, you're still going to have monetary policy that's largely accommodative."

Read More Fed bond bubble: Still look like scariest market to you?

State Street Global Advisors is positioned for continued flattening in the yield curve and holds long durations investment grade corporate bonds along with short-duration income instruments.

The yield on 30-year Treasury bonds (U.S.:US30Y) erased earlier losses to trade up slightly at 2.735 percent, while the yields of all other the maturities were in the red.

As recently as February, 10-year yields were at 1.63 percent, according to Ian Lyngen, senior Treasury strategist at CRT Capital, who believes the market is saying the Fed rate hike could be pushed back.

"I think domestic growth is on reasonably good footing in the U.S. and the fact the Fed is ostensibly still on track to get fed funds off zero... even if this pushes it back to December or even next year, the Fed won't be displeased to see some of the elevated levels in equities corrected somewhat," Lyngen said.

"To some extent, it's bringing forward some of the price action we might expect to see on the liftoff hike. This is the question, is the [stock] market pricing in first hike? When we actually do see the event it will have a less dramatic impact."

In a note released on Monday, Barclays said it the central bank is unlikely to raise benchmark rates before March of next year, citing financial volatility and uncertainty surrounding growth in emerging markets. The outlook is a major shift from the firm's previous expectation of a September rate increase.

Separately, Federal Reserve Bank of Atlanta President Dennis Lockhart stuck to his call that the Fed would lift rates this year, but he did not reiterate his previous forecast for a September rate hike. Lockheart, who did not mention this weeks's market volatility, cited the stronger dollar, a weaker yuan and decline in oil prices as headwinds that could complicate growth forecasts.

Concerns surrounding the health of China's economy multiplied caused the benchmark Shanghai Composite index notch up its biggest one-day percentage loss since 2007 on Monday, closing down 8.5 percent.

Read More Summers: Fed could be making a dangerous mistake

European markets were not immune to the sell off , with the pan-European FTSEurofirst 300 closing down about 3 percent.

Oil prices crashed to fresh six and a half year lows on Monday. U.S. light crude for October delivery closed down 5.5 percent, at $38.24 a barrel-the lowest since February 2009. Brent was trading down about 6 percent, at $42.80 a barrel.

What we're watching this week:

While traders will be preoccupied with the extreme moves in global markets, elsewhere the coming week's annual Economic Policy Symposium at Jackson Hole, which brings together academics, financial market participants and many of the world's leading central bankers, could provide important signals as to near-term monetary policy action in the U.S.

In addition, Federal Reserve Vice-Chairman Stanley Fischer will speak later this week.

Thursday will brings this week's data highlight, with the second reading of U.S. second quarter gross domestic product (GDP).

Some important housing data is also due for release throughout the week, including the release on Tuesday of the FHFA and Case-Shiller home price indices and new home sales figures, followed on Thursday by pending home sales data.

-CNBC's Patti Domm and Jenny Cosgrave contributed to this report.



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