Treasuries Surge as Fed Lowers Forecast for 2016 Rate Increases

  • Policy makers expect two hikes this year, down from four
  • Two-year note yield plunges by the most since September

Treasuries surged, with two-year note yields falling by the most in six months, after the Federal Reserve left interest rates unchanged and lowered its projected path for increases this year.

Yields fell after Federal Open Market Committee officials cited the potential impact from weaker global growth and financial-market turmoil on the U.S. economy in a statement at the conclusion of their two-day meeting. After weeks of financial-market volatility at the start of 2016, traders were ahead of the Fed, having already ratcheted back wagers on rate increases this year.

“The market and the FOMC are more aligned today than they were yesterday,” said Kevin Giddis, head of fixed income at Raymond James & Associates in Memphis, Tennessee. “The fact that they are incorporating global events into their Fed policy is a departure, but it’s weighing on their decision."

Treasury 10-year yields have fallen since the Fed in December lifted its lending benchmark for the first time in almost a decade and issued forecasts signaling it could raise rates four times this year. Policy makers lowered that projection Wednesday to two increases by year-end. 

Yields on two-year notes, the security most sensitive to Fed policy, fell 11 basis points, or 0.11 percentage point, to 0.86 percent as of 5 p.m. New York time Wednesday, according to Bloomberg Bond Trader data, the biggest plunge since Sept. 17. The price of the 0.75 percent note due February 2018 rose 7/32, or $2.19 per $1,000 face amount, to 99 25/32. The yield earlier had touched the highest in more than two months.

Yield Curve

Benchmark Treasury 10-year yields fell six basis points to 1.91 percent. The yield in February touched the lowest since 2012 as a global stock-market rout and plunging oil prices boosted demand for haven assets and led traders to pare bets on the pace of Fed tightening.

The gap between yields on two-year Treasuries and 30-year bonds -- which are more influenced by expectations for inflation and economic growth -- rose by the most in three months, climbing nine basis points to 185 basis points. It fell on Tuesday to the least since 2008.

The FOMC kept the target range for the benchmark federal funds rate at 0.25 percent to 0.5 percent. The median of policy makers’ updated quarterly projections, known as the dots, saw the rate at 0.875 percent at the end of 2016, compared with the 1.375 percent level forecast in December.

‘Dovish’ Tone

"It was much more dovish than anyone was expecting," said Gemma Wright-Casparius, head of the Treasury and inflation team from the Valley Forge, Pennsylvania, trading floor of Vanguard Group Inc., which manages $3.4 trillion. "The lowering of the pace of hikes is the big thing, and the lower terminal" rate.

The median of Fed officials’ projections saw the federal funds rate at 1.875 percent at the end of 2017, compared with 2.375 percent forecast in December. The end-2018 level fell to 3 percent, from 3.25 percent, with the longer-run projection at 3.25 percent, down from 3.5 percent.

“What was always so bull-headed about the Fed’s position was them saying, ‘No, you don’t understand, inflation’s coming back over some extended period of time,”’ said Jim Vogel, an interest-rates strategist at FTN Financial. “This has to be called dovish at this point.”

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