BOND REPORT: 2-year Treasury Yield Posts Biggest One-day Drop In Three Weeks After Fed Raises Rates

By Mark DeCambre, MarketWatch, Sunny OhFeaturesDow Jones Newswires

The Federal Reserve raised rates for the third time this year

Treasury prices rose Wednesday, pushing yields lower after a report on inflation came in line with expectations, but the Federal Reserve's willingness to hike rates aggressively next year came into question, with a lack of change to its muted inflation outlook.

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As expected, the Fed decided to raise interest rates for the third time this year but kept rate projections for 2018 unchanged.

What are Treasury yields doing?

The 2-year note yield , the most sensitive to interest-rate policy, fell 4.3 basis points to 1.786%, the biggest one-day drop since Nov. 22. The yield on the 10-year Treasury note slipped 5 basis points to 2.353%. The yield was as high as 2.42% earlier in the session. While, the yield of the 30-year bond declined 4.5 basis points to 2.738%.

Bond prices and yields move inversely.

What's driving the bond market?

The Fed's policy-setting Federal Open Market Committee raised short-term interest rates by a quarter percentage point to a range of 1.25% and 1.5%, the fifth such increase since Chairwoman Janet Yellen's central bank began raising rates from near zero at the end of 2015. A lack of changes made to Fed members' projections for future interest rates, known as the dot plot, kept trading subdued.

See: Fed lifts interest rates but sticks to go-slow approach as Yellen era nears end (http://www.marketwatch.com/story/fed-raises-interest-rates-and-makes-few-changes-to-outlook-ahead-of-transition-to-powell-2017-12-13)

On the data front, the consumer-price index rose 0.4% in November, matching MarketWatch economists' forecasts. But investors reacted to the smaller 0.1% gain in the so-called core rate of inflation that strips out for food and energy. Economists polled by MarketWatch had predicted core inflation to hit 0.2% this month.

The dollar and Treasury yields reversed course after rising earlier in the day, as the data affirmed expectations that the weakness in inflation would continue, and make Fed members more cautious about future interest-rate hikes next year. Still, investors said the tepid reading wouldn't deter the Fed from hiking rates later Wednesday.

Stubbornly low inflation, running below the Fed's annual 2% target, has been a focus for bond investors because rising inflation can diminish the future value of fixed-income assets. Muted inflation levels have held long-dated bond yields, the most attuned to shifts in the inflation outlook, in check throughout 2017.

See: Higher gas prices boost inflation, squeeze paychecks in November, CPI finds (http://www.marketwatch.com/story/higher-gas-prices-boost-inflation-squeeze-paychecks-in-november-cpi-finds-2017-12-13)

What are market participants saying?

"Today was never really about the hike - that's been in the bag for a while - it's about what the Fed does next. It's clear that the Fed thinks it can hike three more times next year. But that's a forecast that markets don't yet buy, and it's data more than rhetoric that will ultimately convince investors," said Luke Bartholomew, investment strategist at Aberdeen Standard Investments.

"Despite what may be said in the statement and presser today, the lack of robustness of inflation data very much brings the continued hawkishness of the Fed into question," said Aaron Kohli, fixed-income strategist at BMO Capital Markets.

What else is on investors' radar?

Both the Bank of England and the European Central Bank meet on Thursday. U.K. inflation rose at an annual rate of 3.1% in November.

What are other assets doing?

The German 10-year government bond yield was at 0.311%, compared with 0.297% on Tuesday, while the U.K. 10-year bond yield was at 1.215%, versus 1.205% in the prior session.

(END) Dow Jones Newswires

December 13, 2017 16:02 ET (21:02 GMT)