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* Fed's Dudley says Fed may shrink balance sheet this year
* U.S. annual inflation rose most in five years
* Treasuries also supported by month-end buying
By Gertrude Chavez-Dreyfuss
NEW YORK, March 31 U.S. Treasury debt yields
fell on Friday after a chorus of Federal Reserve officials
questioned the need for a faster pace of interest rate increases
given tame inflation and just modest growth in the U.S. economy.
Treasury prices, which move inversely to yields, were also
supported by institutional investor buying to meet routine
month-end and quarter-end portfolio adjustments, analysts said.
New York Fed President William Dudley, St. Louis Fed
President James Bullard and Minneapolis Fed President Neel
Kashkari said on Friday they expect rate increases this year,
but each struck a cautious tone about the U.S. economy.
Investors are currently pricing in two more interest rate
increases in 2017 after the Fed raised rates at its last policy
Dudley, who is also the vice chairman of the Federal Open
Market Committee and a known supporter of low interest rates,
said the Fed is not in a huge rush to tighten policy since the
economy is not overheating. Bullard echoed the sentiment, as did
Jennifer Vail, head of fixed income of The Private Client
Reserve, at U.S. Bank in Portland, Oregon said the Fed
officials' remarks, specifically from Dudley and Bullard, helped
pushed yields lower.
"When Dudley speaks, given his role in the FOMC, it kind of
eclipses many of the other folks that speak in the marketplace,"
All three officials also pushed for shrinking the Fed's
balance sheet, with Dudley saying the Fed could actually do so
this year, earlier than what most economists have expected.
Comments on shrinking the balance sheet, which Dudley said
was tantamount to raising rates, steepened the yield curve,
after a flattening trend the last two weeks.
The gap between the yields of shorter-dated and longer-dated
Treasuries widened on Friday, with the spread between the
two-year and 10-year notes rising to as much as
115.10 basis points, the steepest in a week.
Shrinking the balance sheet typically leads to a steeper
yield curve. Allowing Treasury bonds and notes to roll off
without replacing them with new ones while keeping the fed funds
rate relatively low, would cause long-term rates to rise sharply
while putting a lid on short-term rates.
U.S. economic data on Friday, meanwhile, was a mixed bag,
with the rise in year-on-year inflation to a nearly five-year
high, a stronger-than-expected factory activity in the U.S.
Midwest and easing consumer sentiment for March.
The report backed the Fed's view that the U.S. economy is
growing at a steady, but not a rapid pace.
In late trading, U.S. 10-year notes were up 6/32
in price to yield 2.396 percent, compared with 2.418 percent on
U.S. two-year note yields were at 1.257 percent,
down from 1.286 percent late on Thursday.
(Reporting by Gertrude Chavez-Dreyfuss; Editing by Steve