(Bloomberg) -- To make money betting on the Federal Reserve this week, investors would have done well following traders of the dollar, not Treasuries.
The greenback slumped 1.3% in the month through Tuesday, even as yields on two-year Treasuries climbed 0.25 pentage point as bond traders braced for a hawkish Fed. The dollar's descent proved to be more predictive, at least this time, as central bank policy makers shaved 50 basis points from their 2016 rate outlook, sending both the U.S. currency and Treasury yields tumbling Wednesday.
"The thinking was that the macro story for a data-dependent Fed was looking a lot better and justifying a middle-of-the-road, neither hawkish nor dovish, policy statement, and instead we got this," said John Velis, a Boston-based senior macro strategist at State Street Global Markets, a unit of State Street. "Dollar traders were looking at the other sides of the trade. They were looking at European Central Bank, they were looking at Bank of Japan and they were looking at the People's Bank of China."
Hedge funds cut futures bets on greenback strength to the least since July 2014 last week, while large speculators boosted their expectations for higher U.S. yields, reports from the Commodity Futures Trading Commission show.
Some of the bond market's biggest names, including Pimco and Goldman Sachs, headed into the central bank's meeting confident that policy makers would outline at least three rate increases by the end of the year amid an uptick in inflation. Yet Citigroup -- the world's largest foreign-exchange trader -- correctly predicted a dovish statement and modest pressure on the dollar.
Treasury two-year note yields fell 0.01 percentage point Thursday to 0.85% after plunging 0.11 percentage point Wednesday. The Bloomberg Dollar Spot Index, which tracks the greenback versus 10 peers, extended losses Thursday, reaching the lowest level since June.
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