Bond Traders Smash Yield Curve Flatter on Fed Inflation Mystery

Reuters

Shares of U.S. banks shot to a six-month high on Wednesday afternoon, lifted by a sharp rise in bond yields after the U.S. Federal Reserve signaled it was likely to raise interest rates again by the end of the year.

The policymaking Federal Open Market Committee (FOMC) agreed to keep its benchmark rate target at 1%-1.25%, forecasting at least one more hike this year.

Hurricanes are unlikely to materially impact economy in medium term, according to the Fed's statement.

The cause of the spike in the Dollars was arguably the fact that the dot plot or perceived course of hikes from the Fed continued to expect one hike this year and three next year.

South Africa's rand weakened to a five-week low against the dollar on Tuesday before the central bank's interest rate decision this week and the U.S.

In July, the core personal consumption expenditure (PCE) index, Fed's favor inflation indicator, rose only 1.4 percent year on year, below Fed's two percent target and also lower than the 1.9 percent in January.

The withdrawal of QE will mean that the supply of bonds will go up over time, other things remaining the same, which should increase USA bond yields. At present, the market has a 60% expectation of a rate hike in December.

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"The devastation of hurricanes Harvey and Irma will no doubt cast a shadow over the third quarter's growth figures too, which the Fed will be watching closely, but this should be a temporary effect", Ms Curtin said.

US benchmark West Texas Intermediate (WTI) crude futures CLc1 hit a four-month high of $50.79 per barrel and last traded at $50.71, flat from the USA close on Wednesday. Inflation has been the key economic factor keeping the Fed from pulling the trigger, so it will be particularly important for investors to get the Fed's latest thinking on that issue.

Now, with a much stronger economy, Fed officials are expected to announce a starting date to begin allowing the bond holdings to shrink gradually. Inflation has stalled, and prices are now rising just 1.4 percent annually.

In June the Fed announced it was considering reducing the number of assets - amounting to circa 3.7 trillion - that it owns on its balance sheet.

So far this month, the 2-year Treasury yield has climbed more than 10 basis points, the benchmark 10-year note yield has tacked on more than 12 basis points, while the yield on the 30-year bond has advanced about 6 basis points, thus far in September. The Fed, though, has yet to achieve its other objective of stabilizing prices at a 2 percent annual rate.

The Federal Reserve will begin shrinking the enormous portfolio of bonds that it amassed after the 2008 financial crisis to try to sustain a frail economy. Yellen's four-year term as chair will end on February 3.

Referring to the Fed's projection of member's expectations of future interest rates, illustrated in a dot plot diagram on the Fed's website, where dots represent each of the 16 voting and non-voting Fed member's projections of future interest rates, he suggests the main clusters of dots - or median expectation - may drop. "Our balance sheet is not meant to be an active tool for monetary policy in normal times", Ms. Yellen emphasized Wednesday, adding that "we therefore do not plan on making adjustments to our balance-sheet normalization program".

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