September 21, 2017 / 6:30 PM / 10 months ago

TREASURIES-U.S. yield curve flattest since July on possible Dec rate hike

 (Adds quote, outlook; updates prices)
    * Fed seen as more hawkish than market anticipated
    * Philly Fed manufacturing index increases
    * PCE index in focus next week for inflation clues

    By Karen Brettell
    NEW YORK, Sept 21 (Reuters) - The U.S. Treasury yield curve
flattened to two-and-a-half month lows on Thursday as investors
adjusted for the likelihood of a  December interest rate
increase, a day after the Federal Reserve struck a
more-hawkish-than-expected tone at its September meeting.
    New economic projections released after the Fed's two-day
policy meeting showed 11 of 16 officials see the "appropriate"
level for the federal funds rate, the central bank's benchmark
interest rate, to be in a range between 1.25 percent and 1.50
percent by year-end.             
    "The meeting was definitely more hawkish than what the
market was anticipating," said Mary Ann Hurley, vice president
in fixed income trading at D.A. Davidson in Seattle. "We were
definitely not pricing in another rate hike for this year."
    The yield curve between Treasury five-year notes and 30-year
bonds                flattened to 92 basis points on Thursday,
the lowest level since July 6.
    Intermediate-dated debt is highly sensitive to interest rate
increases, helping them underperform, while longer-dated bonds
are influenced by inflation expectations.
    Some traders and investors had expected the Fed to strike a
more dovish tone given the potential economic impact of recent
severe hurricanes and still sluggish inflation.
    The U.S. central bank was also seen as potentially slowing
its rate hike path to give the market time to absorb reductions
in its balance sheet.
    Personal income data released on Sept. 29 will be the next
major focus for signs of whether inflation is picking up.
    "I have a hard time seeing how if we don’t get an uptick in
the PCE core and some kind of move higher in the real neutral
fed funds rate between now and the end of the year, that they’re
going to stand pat this year," said Lou Brien, a market
strategist at DRW Trading in Chicago.
    The core personal consumption expenditures (PCE) index,
which excludes food and energy prices, is the Fed's preferred
measure of inflation.
    The Treasury Department saw soft demand for a $11 billion
sale of 10-year Treasury Inflation-Protected Securities (TIPS)
on Thursday, which sold at yields more than 2 basis points
higher than they had traded before the auction.             
    Data on Thursday showed that manufacturing activity in the
mid-Atlantic region accelerated in September amid a surge in new

 (Editing by Dan Grebler)
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