* Fed raises rates by a quarter point
* Fed sees 3 more rate hikes in 2017, pushes yields higher
* Yield curve flattens (Updates prices, adds comment)
By Gertrude Chavez-Dreyfuss and Dion Rabouin
Dec 14 (Reuters) - Shorter-dated U.S. Treasury yields surged on Wednesday, with those on two-year notes climbing to their highest in more than seven years after the Federal Reserve raised interest rates for the first time in a year and flagged more rate increases in 2017.
Yields on two-year Treasury notes rose to their strongest level since August 2009, while three-year yields hit their highest since May 2010. U.S. five-year yields rose to their highest since May 2011 and seven-year yields hit a 2-1/2-year peak.
Shorter-dated maturities are the most vulnerable to the Fed’s monetary policy moves as an increase in U.S. overnight rates reduces their value most immediately.
Benchmark U.S. 10-year yields meanwhile climbed to more than two-year peaks.
The Federal Open Market Committee, which raised rates by a quarter point on Wednesday, said it anticipates lifting rates three more times in 2017, an increase from the Fed’s September meeting at which the committee said it expected just two hikes.
The increase of 25 basis points to 0.50-0.75 percent was largely expected but the expansion of the Fed’s so-called dot plot caught the market slightly off guard, analysts said.
But more important than next year’s expected faster pace of tightening was that the Fed’s longer-run outlook for growth and inflation remained unchanged, leaving the longer-term path for rates little changed, said Lindsey M. Piegza, chief economist at Stifel Fixed Income in Chicago.
“The Committee sees the potential for a modest uptick in prices and activity over the next 12-24 months, but in the long run, the Fed’s forecast for a moderate trajectory of the economy remains,” said Piegza.
“Despite the market’s more optimistic view with pro-growth policies potentially ushered in next year, the Fed expects to maintain a slow and ‘gradual’ pace.”
In late trading, U.S. two-year Treasury notes were last down 5/32 in price to yield 1.263 percent, an increase of 9 basis points from late on Tuesday. The three-year note dropped 10/32 to yield 1.578 percent, a gain of 11 basis points. The five-year note fell 18/32 to yield 2.032 percent, up 12 basis points.
U.S. 10-year Treasury notes dropped 21/32 to yield 2.559 percent, 8 basis points higher than on Tuesday.
The yield curve was also flatter, with the spread between the U.S. two-year and 10-year notes at around 130 basis points. The flatter yield curve was an acknowledgement to the additional rate hike implied in the Fed dot plots, said Marvin Loh, global market strategist at BNY Mellon in Boston. (Reporting by Dion Rabouin; Editing by Bill Trott and Meredith Mazzilli)