By Min Zeng
Prices of U.S. government bonds pulled back slightly, with the two-year note's yield trading near a seven-year high, after the Federal Reserve's minutes for its December policy meeting generated a mild bout of price swings.
Bond yields initially fell as the minutes showed officials grappled with " considerable uncertainty" about the effect the incoming U.S. administration could have on the economy. Yields then ticked higher, reflecting some investors' optimism that expansive fiscal stimulus proposed by President-elect Donald Trump will lead to stronger growth and higher inflation, which would require the Fed to raise rates at a faster pace than many investors expect.
The yield on the benchmark 10-year Treasury note fell to 2.435% after the minutes but settled at 2.452%, compared with 2.450% Tuesday. Yields rise as bond prices fall.
Higher interest rates from the Fed tend to shrink the value of outstanding bonds. Yields on short-term debt are particularly sensitive to the central bank's policy outlook.
The yield on the two-year note settled at 1.210%, compared with 1.199% Tuesday. The yield closed at 1.261% on Dec. 15, the highest since 2009.
"The minutes could easily be read ambiguously," said Christopher Sullivan, chief investment officer at United Nations Federal Credit Union. "What seems evident is that the Fed will be sensitive to fiscal policy changes."
Bond yields have risen after closing at record lows during the summer, reflecting a shift among investors from worries over sluggish growth and low inflation. Mr. Trump's win in the U.S. election has accentuated the shift. The Fed raised short-term interest rates in December for the second time in a decade and projected three rate increases this year, which had contributed to one of the biggest bond-market selloffs since the financial crisis.
The minutes showed that officials emphasized the timing, size and composition of Mr. Trump's proposals once he takes office are wild cards in deciding how to adjust interest rates.
If there will be more fiscal expenditures, it will "allow the Fed to hike faster," said Praveen Korapaty, head of interest-rate strategy at Credit Suisse. "Both mean higher yields."
James DeMasi, chief fixed-income strategist at Stifel Nicolaus Co., said the recent bond rout already reflected investors' optimism toward the fiscal and growth outlook, which is likely to limit the pace of further yield gains from here.
He expects the two-year yield to rise modestly to 1.5% at the end of 2017.
Despite the Fed's projections of three rate increases, some investors and analysts say they expect the Fed to raise rates one to two times this year.
Factors that would contain the Fed's pace of tightening, they say, include the risk that Mr. Trump's policy outcome may be disappointing and fail to generate stronger U.S. growth. A stronger dollar -- which had rallied since the election -- will hurt U.S. exports and corporate earnings from overseas operations. In addition, the U.S. economy is still prone to external shocks.
"The risk is that the Fed tries to downplay the increases in [its rate-increase projections] by emphasizing the fact it only took a couple forecast changes to tip the scale," said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.
The Fed's next policy meeting is scheduled for Jan. 31 and Feb. 1.
Interest-rate-derivative markets show investors expect the Fed is likely to hold steady for a few months and raise rates again this summer.
Fed funds futures, a popular derivative market for investors and traders to place bets on the Fed's rate-policy outlook, showed a 69% probability of the Fed raising interest rates by the June 2017 meeting, according to CME Group.
The odds for the Fed to raise rates by at least a quarter of a percentage point by the December 2017 meeting were 95%.
Write to Min Zeng at email@example.com
(END) Dow Jones Newswires
January 04, 2017 15:48 ET (20:48 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.