Short end dips, yield curve steepens after moderate Fed speech

NEW YORK: Yields on shorter-dated U.S. government bonds fell on Wednesday afternoon, steepening the yield curve, after Federal Reserve Chair Jerome Powell delivered a speech in which he signaled that an end to the bank's interest-rate hike cycle may be closer than previously suggested.

In a speech that comes in the wake of another volatile market selloff, Powell said that interest rates are now "just below" estimates of neutral less than two months after saying rates were probably "a long way" from that point.

The U.S. central bank in 2018 has hiked rates each quarter, and is expected to tighten policy again next month. But signs of a slowdown overseas and nearly two months of market volatility - including a sharp sell-off in equities last week - have clouded an otherwise rosy picture of the U.S. economy.

Powell said on Wednesday that the economic effects of the Fed's policy tightening may take a year or more to appear. "That may just be saying this stuff affects (the economy) with a lag - it may also be saying that without inflation nipping at our heels here, we may need to take some significant time off to see what we've done," said Lou Brien, market strategist at DRW Trading.

Two-year treasury yields, which reflect traders' rate-hike expectations, dropped 3 basis points, last at 2.80 percent. The shorter end of the yield curve fell faster than the long end, widening the spread between two- and 10-year yields  by 1.9 basis points.

Longer-dated federal fund futures also ticked higher, suggesting diminished expectations for hikes after December. According to CME Group's FedWatch tool, the probability of a December rate hike rose today, while it declined for the meeting in March 2019.

"It looks like one more hike is baked into the cake this year. If you follow the dot plots as consensus, there should be two more hikes next year, though that is not guaranteed and will be data dependent," said Michael DePalma, chief executive, PhaseCapital LP.

The Treasury Department sold $32 billion in seven-year notes - the largest auction at this maturity since April 2010 - earlier to strong demand. A group of buyers allowed to place orders directly with the government known as direct bidders took 27 percent of the offering, the biggest amount since March 2014.

Bond issuance has risen steadily this year to pay for President Donald Trump's tax cuts and spending increases. Although market participants have worried that the increased supply will diminish demand, some of that fear may have been waylaid by strong results at the three note auctions this week.