* Fed's Dudley: bank may shrink balance sheet this year
* U.S. annual inflation rose most in five years
* Chicago PMI was stronger-than-expected
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By Gertrude Chavez-Dreyfuss
NEW YORK, March 31 U.S. Treasury debt yields
were mostly lower on Friday after New York Federal Reserve Bank
President William Dudley said the central bank was not in a
huge rush to tighten monetary policy since the economy is not
Yields on U.S. 30-year bonds were higher, however, because of
rebalancing of portfolios by pension funds for month-end
purposes, analysts said.
Investors have currently priced in two more interest rate
increases in 2017 after the Fed hiked at its last policy
In an interview with Bloomberg TV, Dudley, a voter on the
Federal Open Market Committee and a known supporter of low
interest rates, said a couple more rate increases in 2017 seem
reasonable but that there is no great urgency.
He also said the Fed could begin shrinking its $4.5 trillion
balance sheet as soon as this year, earlier than what most Wall
Street economists expect.
"What you saw in the short-term interest rate market
initially was a bit of a dovish perception in response to
Dudley's comments," said Guy LeBas, chief fixed income
strategist at Janney Montgomery Scott in Philadelphia.
However, Dudley's comments on shrinking the balance sheet,
which the Fed official said was tantamount to raising rates, did
steepen the yield curve, after a flattening trend the last two
The gap between the yields of shorter-dated and longer-dated
Treasuries increased on Friday, with the spread between the
two-year and 10-year rising to as much as 114.60
basis points, the steepest in a week.
The curve steepened because Dudley's comments suggested that
by reducing its balance sheet, the Fed would sell some bonds or
pause buying them, which should push rates on the long end of
the curve higher, analysts said.
Friday's U.S. economic data was a mixed bag, with a report
showing the largest annual increase in U.S. inflation in nearly
five years. The personal consumption expenditures (PCE) price
index rose 2.1 percent year-on-year, the biggest such gain since
Factory activity in the U.S. Midwest for March, on the other
hand, was more robust than expected, but consumer sentiment as
measured by the University of Michigan eased this month.
The net effect on Treasuries was still lower yields, except
on U.S. 30-year bonds.
In mid-morning trading, 10-year notes were up
2/32 in price to yield 2.410 percent, compared with 2.418
percent on Thursday.
U.S. two-year note yields were at 1.265 percent,
down from 1.286 percent late on Thursday.
The U.S. 30-year bond, meanwhile, was down 7/32
in price, yielding 3.038 percent, up from Thursday's 3.026
(Reporting by Gertrude Chavez-Dreyfuss)