BOND REPORT: Treasury Yields Erase Gains After Consumer-inflation Report

Federal Reserve is expected to raise rates for third time this year

Treasury yields retreated on Wednesday after a report on inflation came in line with expectations, but cast some doubt Federal Reserve's willingness to hike rates aggressively next year.

The inflation reading comes ahead of the Fed's key decision that is anticipated to result in the third interest-rate increase of 2017. Investors in government paper are expected to focus on the central bank's inflation outlook and its assessment of the health of the U.S. economy, both of which will factor in the pace of policy normalization in 2018.

What are Treasury yields doing?

The yield on the 10-year Treasury note was at 2.374%, compared with 2.403% late Tuesday in New York. The yield was as high as 2.42% earlier in the session. The 2-year note yield , the most sensitive to interest-rate policy, was at 1.819%, versus 1.829% in the previous session, while the yield of the 30-year bond was at 2.751%, compared with 2.782% on Tuesday.

Bond prices and yields move inversely.

What's driving the bond market?

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)

Wall Street is anticipating that the Fed's policy-setting Federal Open Market Committee will raise short-term interest rates by a quarter percentage point to a range of 1.25% and 1.5%, the fifth such increase since the Janet Yellen's central bank began raising rates from near zero at the end of 2015. An updated policy statement, and Fed members' projections for future interest rates, known as the dot plot, will be released at 2 p.m. Eastern Time. Yellen is scheduled to field questions from reporters a half-hour later in her final news conference before she retires and is replaced by Fed. Gov. Jerome Powell.

Investors will be eager to hear the Fed's expectations for economic growth, especially in light of House and Senate lawmakers's efforts to pass a potentially business-boosting tax policy.

What are market participants saying?

"As we highlighted recently, we expect the FOMC to be rather neutral for U.S. yields. A hike in December is a done deal and we do not expect changes in the 'dots'," wrote analysts at UniCredit in a Wednesday research note (https://www.research.unicredit.eu/DocsKey/economics_docs_2017_162946.ashx?M=D&R=54890432).

"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, providing some support to the notion that puzzling inflation may beginning to normalize.

What are other assets doing?

The German 10-year government bond yield was at 0.312%, 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 09:23 ET (14:23 GMT)