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Treasury Yields, Dollar Surge as Fed Raises Odds of December Rate Hike

James Hyerczyk
U.S. Federal Reserve
U.S. Federal Reserve

U.S. Treasury yields reached more than a two-month high after the U.S. Federal Reserve said it would begin reducing its $4.5 billion balance sheet starting in October. All nine members of the monetary policy committee voted for the action.

The U.S. 2-year Treasury yield hit a high of 1.430 percent, its highest level since July 6. The U.S. 10-year Treasury yield climbed to 2.264 percent, its highest level since August 1. The 30-year Treasury yield edged up to 2.82 percent.

Current Fed policy requires the central bank to reinvest the proceeds from maturing bonds. Today, the Fed signaled it wants to wind down those reinvestments this year.

The announcement of the balance sheet trimming was the biggest news from Wednesday’s meeting. Additionally, the Federal Open Market Committee left its benchmark interest rate unchanged at <1.25 percent.

The FOMC did indicate a possible third rate hike before the end of the year, which would bring the target up to between 1.25 percent and 1.50 percent.

The central bank also downplayed the impact of Hurricanes Harvey and Irma on the economy, saying that they “are unlikely to materially alter the course of the national economy over the medium term,” other than temporarily lifting inflation because of higher prices for gas and other goods for which the supply chain was disrupted.

Fed members also said that they now project faster growth for 2017, with a median forecast of 2.4 percent gross domestic product growth, versus a June projection of 2.2 percent.

As far as reducing the balance sheet is concerned, Fed officials said that they will reduce it by $10 billion in Treasury and mortgage-backed securities a month, to start, by allowing bonds to mature without buying new ones.

The reaction in the Treasury markets was volatile as expected. Stocks traded mixed and the U.S. Dollar surged. Today’s messaging from the Fed essentially drove investors into the U.S. Dollar since the odds of a rate hike in December increased based on the Fed’s statement.

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