BOND REPORT: Treasury Yields Steady As Traders Brace For Fed Meeting Decision

By Mark DeCambre, MarketWatch , Sunny Oh Features Dow Jones Newswires

Fed gathering is underway and slated to finish with Wednesday's announcement at 2 p.m. Eastern

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Treasurys were mostly unchanged Tuesday as traders looked past an early raft of economic data releases to await an important policy-setting gathering of the Federal Reserve, which could determine the outlook for government paper for 2018.

The benchmark 10-year Treasury yield was at 2.239%, compared with 2.230% the day before, while the 30-year bond yield edged higher to 2.810%, versus 2.804% late Monday in New York.

However, the two-year note yield , the most sensitive to Fed moves, was at 1.401%, little changed compared with 1.393% in the previous session.

Bond prices and yields move inversely.

The policy-setting Federal Open Market Committee is widely expected to announce the beginning of an unwind of its $4.5 trillion portfolio of government securities when it releases its policy update Wednesday.

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In a Goldman Sachs note dated Sept. 15 led by David Kostin, chief U.S. strategist, the bank said it expects the Fed to say its balance-sheet normalization will begin in October.

Although rates are forecast to stay steady, the asset-portfolio reduction and any signal from the central bank about recalcitrant levels of inflation will be closely watched, with the move likely rippling through other assets as yields tick higher.

Check out: Fed's balance-sheet unwind will be moment of truth for financial markets (http://www.marketwatch.com/story/feds-balance-sheet-unwind-will-be-moment-of-truth-for-financial-markets-2017-09-18)

See:Why the bond market isn't freaking out from the Fed's shift to quantitative tightening (http://www.marketwatch.com/story/why-the-bond-market-isnt-freaking-out-from-the-feds-shift-to-quantitative-tightening-2017-09-14)

The effect of the central bank's unprecedented asset unwind is unknown, as the Federal Reserve is the first to attempt to wind down a legacy of post-financial crisis monetary policy. But some strategists are offering projections.

"We expect the announcement next week of Fed balance-sheet normalization, to begin in October, will lift 10-year Treasury yields via the term premium and put modest downward pressure on equity valuations. Bank stocks, which no longer carry their postelection policy premium, are poised to profit from higher yields and a steeper curve," Goldman wrote Friday.

Read:Fed to take historic leap into the unknown (http://www.marketwatch.com/story/fed-to-take-historic-leap-into-the-unknown-2017-09-14)

The "term premium" refers to a differential between bonds with shorter maturities relative to those with longer maturities. Recently the premium between two-year and 10-year notes has narrowed, which can imply a bearish outlook on inflation.

Goldman is expecting for the 10-year yield to climb in absolute terms, but also relative to its short-dated counterpart, steepening the so-called yield curve, which should be beneficial to banks that borrow short term and extend loans on a longer-term basis. Meanwhile, higher yields might lure some investors away from assets perceived as risky, like stocks, to find richer yields, with the Dow Jones Industrial Average and the S&P 500 index on Tuesday being pushed to all-time highs (http://www.marketwatch.com/story/dow-sp-500-line-up-for-fresh-records-to-start-the-week-2017-09-18).

The reduction of the Fed's balance sheet, accumulated during the heart of the 2007-'09 financial crisis, also is expected to have a tightening effect on rates, pushing them higher along with the central bank's rate-hike efforts. Wall Street is pricing in a nearly 60% chance of a rate increase before the end of 2017, up from around 37% about a month ago, according to CME Group data (http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html).

To mute the impact, the Fed is expected to take baby steps in the unwind. The current plan calls for the balance sheet to initially shrink by only $10 billion a month. The pace of the rundown would then increase by $10 billion every quarter, up to a maximum of $50 billion a month.

With the policy announcement due Wednesday, traders gave a short shrift to early data releases. A report on construction on new houses in August showed a decline of 0.8% to an annual rate of 1.18 million (http://www.marketwatch.com/story/housing-starts-dip-in-august-but-permits-surge-in-sign-of-optimism-2017-09-19), but a jump in new permits of 5.7% suggested the dip would be temporary. The government said the data wasn't muddied by Hurricane Harvey, which inundated huge swaths of Texas and Louisiana.

Meanwhile, import prices climbed 0.6% in August (http://www.marketwatch.com/story/cost-of-imported-goods-surge-in-august-led-by-fuel-2017-09-19), but have only showed a gain of 2.1% for the past 12 months, suggesting the U.S. isn't importing much inflation despite the weaker dollar.

Since the beginning of the year, the ICE Dollar index , a gauge of the greenback's strength against six major counterparts, has shed more than 10% of its value. But some argue the inflationary pressures from a depreciating dollar would kick in soon.

"The dollar's falling. That's inflationary, period. You've got to spend more on goods and services, but you're getting a lag effect," said John Lekas, portfolio manager at Leader Capital.

The delay was a result of U.S. companies cutting prices to compete against cheaper imported wares, he said. The battle to defend market share, however, can only last so long if earnings start to deteriorate.

(END) Dow Jones Newswires

September 19, 2017 16:21 ET (20:21 GMT)