U.S. government bonds pared a price rally as some investors took some chips off the table after the Federal Reserve's announcement to raise short-term interest rates.
The Fed's decision was widely expected by investors. While the Fed gave a nod to slowing inflation, policy makers maintained their forecast that another rate increase is still likely during the second half of the year.
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The central bank disappointed some bond investors looking for stronger signals in slowing down the pace of rate increases in the second half of the year, said some analysts.
The yield on the two-year note, highly sensitive to the Fed's rate-policy outlook, rose to 1.323% from 1.299% right before the Fed, according to Tradeweb. Yields rise as bond prices fall. The yield was still down from 1.363% Tuesday.
The yield on the benchmark 10-year note was 2.129% compared with 2.115% before the Fed. The yield was still down sharply from 2.206% Tuesday.
Bond prices on Wednesday had rallied ahead of the Fed's rate decision as the latest consumer price index data pointed to slowing inflation. The data bolstered some investors' belief that the central bank may hold off raising rates during the second half of the year, and the view boosted demand for Treasurys.
The consumer-price index last month was up 1.9% on an annualized base, dipping below the Fed's 2% target again. Excluding food and energy, CPI rose 1.7% over the past 12 months through May, the smallest gain since May 2015.
Inflation chips away investors' purchasing power from their government bond investments over time and is a big threat to long-term Treasurys. Demand for long-term bonds rises when investors expect inflation to ease.
Demand for long-term bonds was so strong that on Wednesday the yield premium on the 10-year note relative to the two-year note fell to 0.815 percentage point. This would be the lowest level since September on a close basis, according to Tradeweb. The premium was 0.75 percentage point on July 8, 2016, the smallest since Nov 2007.
A shrinking premium is known as a flattening yield curve in the bond market. It is usually interpreted by investors as a warning sign that the growth momentum may be slowing down, leading to diminished inflation pressure.
The bond market has caught those betting on higher yields wrong-footed this year. The 10-year Treasury yield has fallen from 2.446% at the end of 2016, even as the Fed raised rates in December and again in March. The bond market is countering against the consensus trade leading into 2017 that yields would extend their climb in late 2016.
A number of factors have sent yields lower instead: growing skepticism toward President Donald Trump's fiscal agenda; disappointing economic releases that raised some question toward the growth momentum; and U.S. Treasurys remain a bargain with their yields remaining higher compared with their peers in Germany, Japan and the U.K.
Some money managers and analysts say slowing inflation is complicating the Fed's strategy in normalizing its interest-rate policy. The risk for the Fed, say analysts, is that if inflation expectations become unanchored and fall further from here, it would make it harder for policy makers fulfill their inflation mandate. Therefore, the central bank may need to slow down the pace of tightening.
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(END) Dow Jones Newswires
June 14, 2017 14:52 ET (18:52 GMT)