The Daily Prophet: Fed Breathes Life Into Bond Market's Rally

The Federal Reserve raised interest rates on Wednesday for the third time this year and significantly boosted its forecast for economic growth. That would normally be a recipe for disaster in the bond market, but fixed-income investors walked away smiling.

Treasuries -- the benchmark for corporate and consumer borrowing costs --- rallied as yields declined from the high end of their recent range. Even though the Fed raised its benchmark rate by a quarter percentage point to a target range of 1.25 percent to 1.5 percent and lifted its estimate for economic growth next year to 2.5 percent from 2.1 percent, it still doesn't see inflation accelerating. That's key because faster inflation erodes the purchasing power of fixed-interest payments over time, eroding the value of bonds. The breakeven rate on five-year U.S. government notes, or what traders expect the rate of inflation to be over the life of the securities, fell almost half a percentage point to 1.78 percent, the biggest drop in two months.

DOLLAR RALLY REVERSES
While bond investors celebrated, dollar traders looked like they were broadsided. The Bloomberg Dollar Spot Index hits its lows of the day after the decision, falling the most in three weeks. The index had risen in each of the last seven days, it's longest rally since the start of 2016, on speculation the economy was doing so well that the Fed just might flag that it planned to raise rates four times next year. Alas, the central bank stuck to its outlook for three increases. The losses Wednesday add to a terrible year for the greenback, with the Bloomberg Dollar Spot Index down 7.82 percent. The dollar could lose more ground as the prospect of strong economic growth and tighter monetary policy outside the U.S. more than offsets higher rates at home, according to Bloomberg News' Lananh Nguyen. The economic growth “we’re seeing in Europe, emerging markets and the rest of the world will likely cause the dollar to sell off again,” Erin Browne, the head of asset allocation at UBS Asset Management, which oversees about $770 billion, told Bloomberg News.