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Short-term yields slip after Powell says rates are 'just below' neutral

Short-term U.S. Treasury yields slipped Wednesday after Federal Reserve Chair Jerome Powell said that he thinks the central bank's overnight rate is "just below" a neutral level.

"Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth," Powell told the Economic Club of New York in a speech being closely watched in what has become a volatile financial marketplace.

The yield on the benchmark 10-year Treasury note crept higher to 3.061 percent at 4:56 p.m. ET, while the yield on the 30-year Treasury bond climbed to 3.347 percent. The 2-year Treasury note yield, which is impacted to a greater extent by changes in Fed policy, dropped 2 basis point to 2.813 percent.

The fall in short-term rates contributed to a steeping of the yield curve. The spread between the 2-year yield and the 10-year yield rose to 24 basis points from recent lows near 20.

While FOMC participants’ projections are based on our best assessments of the outlook, there is no preset policy path.
Jerome Powell
Chair of the Federal Reserve

Powell's address came a day after Fed Vice Chair Richard Clarida said something similar, that interest rates are "much closer" to a level that neither stimulates nor restricts growth.

Some central bank officials, including Powell and Clarida, have underscored the importance of the Fed's reliance on financial data when debating further increases to the overnight rate. Weakness in financial markets both in the U.S. and overseas have led some investors to wonder whether Fed members may temper the pace of their rates hikes.

"Powell's speech to the economic club of New York was a bit dovish," Jon Hill, rates strategist at BMO Capital Markets, wrote in an email. "One key point that we're focusing on is that that rates are 'just below' the neutral range. ... However, Powell's note that financial stability has a more integral role for monetary policy suggests a desire to at least continue the hiking path to remove an accommodative stance."

The chairman's October observation that rates were "a long way" from neutral helped spark a turbulent period on Wall Street over the last month. The major stock indexes dipped into correction territory and angst mounted that more rate hikes could derail the economic growth of the past two years.

Lukewarm inflation, a steep drop in oil prices and dwindling effects from President Donald Trump's tax cuts have also added to concerns that the robust economic growth in the U.S. over the past year may be coming to a end.

Jerome Powell, chairman of the U.S. Federal Reserve, speaks during a news conference following a Federal Open Market Committee (FOMC) meeting in Washington, D.C., on Wednesday, June 13, 2018.
Andrew Harrer | Bloomberg | Getty Images

"I think given the volatility we've seen in the equity market and some signals of slowing growth globally and domestically, that the Fed can be a little bit more relaxed with its approach in getting toward it's neutral rate," said Gary Pollack, head of fixed-income trading at Deutsche Bank Private Wealth Management.

Though the central bank did not adjust its plans for further rate hikes when stocks pulled back in February, Pollack said that a decline in inflation expectations and continued contraction in global growth may be enough to soften monetary policy hawks.

Still, other Fed members points to an unemployment rate under 4 percent and burgeoning GDP figures as early evidence of an overheating economy and grounds to goad borrowing costs higher. The Federal Open Market Committee — which seeks to control inflation and maximize employment — has hiked the federal funds rate three times so far this year, emboldened by stronger gross domestic product data and hot jobs numbers.

"It seems that there is a little bit of a softening in his tone from his previous comment, which the market is taking as a sign that rate hikes are going to be slower than anticipated," said Putri Pascualy, managing director for PAAMCO. "However I'd be cautious about reading too much into that. Yes, he's tempered his tone, but if you read the statement, he talks a lot about how things are quite strong."

The current federal funds rate rose to 2.25 percent when the FOMC voted to bump the rate on September 26, 2018. Both the Fed and markets anticipate a fourth rate hike in December.

U.S. Markets Overview: Treasurys chart

Ahead of the chairman's speech, President Trump said to the Washington Post that he wasn't "even a little bit happy" with his appointment of Powell as the Fed's Chair, adding that he thought the central bank's recent actions were "way off-base."

The U.S. Treasury auctioned $32 billion 7-year notes at a high yield of 2.974 percent. The bid-to-cover ratio, an indicator of demand, was . Indirect bidders, which include major central banks, were awarded xx percent. Direct bidders, which includes domestic money managers, bought xx percent.

Elsewhere, trade continues to keep investors on edge. Ahead of a Group of 20 summit in Argentina later this week, Trump told the Wall Street Journal in an interview published Monday that it was "highly unlikely" that the U.S. would delay from increasing tariff levels to 25 percent, in regards to $200 billion worth of Chinese goods.

Trade fears however eased on Tuesday, after White House economic advisor Larry Kudlow said that the administration had resumed talks with China "at all levels." The summit, set to take place on Friday and Saturday, is expected to see both Trump and China's Xi Jinping present.

— CNBC's Alexandra Gibbs and Jeff Cox contributed reporting.