US Treasuries rally on Yellen's testimony

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US Treasuries rally on Yellen’s testimony

Yesterday, global core bonds parted ways. The Bund traded with a downward bias in the European session as Greece and Europe finally agreed on a 4-month bailout extension. US Treasuries were dominated by Yellen’s testimony (see below). While, we didn’t see much changes in the FOMC view versus the January meeting, when the testimony was prepared, Treasuries were clearly positioned for a more hawkish chairwoman. So, when that didn’t materialize, Treasuries climbed substantially higher, but failed to take out key resistance. US equities gained (new high), but ended nearly unchanged. In a daily perspective., the US yield curve dropped up to 8.4 bps (5-yr). Changes on the German yield curve were once more negligible, as early losses were recouped (in sympathy with US Treasuries). Peripheral yield spreads, including Greece, narrowed on the Greek bail-out with decent gains of EMU equities too.

Fed chair Yellen kept her remarks close to the message of the January statement. She remained rather vague about the future outlook for monetary policy during her testimony. The FOMC becomes more data-dependent and will raise rates when appropriate given reasonable confidence inflation will move back towards the 2% objective. There are risks for our June lift-off call, but we found too little elements to change our expectations yet. Of course, the eco data should improve after the recent soft patch. Back to Yellen: a high degree of accommodation remains appropriate (patient). If the Fed would remove the forward guidance, it would suggest the FOMC is considering a rate hike, not that it will hike rates. The assessment will be made on a meeting to meeting basis once the “patient” is dropped. Some of the quotes out of her text. “The FOMC will signal that it is considering a removal of accommodation by changing its forward guidance” "However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings” Improvements to the labour market need to be accompanied by "reasonable" confidence in inflation moving back toward the 2% objective over time.

The eco calendar is thin today with only US new home sales and French jobless data (after market). Fed Chairwoman Yellen will testify to the House Financial Services Committee and ECB’s Draghi will testify to the European Parliament (after market). In December, US new home sales jumped by 11.6% to a total of 481 000 annually, the highest level since 2008. For January, the consensus is looking for a limited decline, by 2.3% M/M to 470 000. We believe however that the risks are for a bigger decline following the strong gain in December and as weather conditions, especially at the end of the month, were unfavourable.

The German Finanzagentur taps the on the run 5-yr Bobl (€4B 0% Apr2020). In the run-up to the auction, the bond cheapened marginally in ASW-spread terms. The past 4 Bobl auctions went dreadful with total bids averaging only €4.14B. We don’t expect much improvement today given negative 5-yr yields. The Portuguese debt agency taps the on the run 10-yr PGB (2.875% Oct2025) for €1-1.25B. Year-to-date, Portugal already managed to raise €6.75B which is almost 50% of this year’s funding needs! The bond didn’t cheapen going into the auction. On the Portuguese yield curve, the bond trades rich. Nevertheless, sentiment versus peripheral bonds remains very strong and the yield pick-up is still interesting in light of economic developments, a possible return to investment grade (Fitch) and the ECB’s QE-programme. Therefore, we expect the auction to go well.

The US Treasury started its end-of-month refinancing operation with a strong $26B 2-yr Note auction. Today, the Treasury continues with a $13B 2-yr FRN auction and a $35B 5-yr Note auction. Currently, the WI of the 5-yr is trading around 1.475%.

Overnight, Asian stocks trade mixed. Chinese stocks return from a week-long holiday, but strangely enough underperform. HSBC Chinese manufacturing PMI returned above 50 and global stocks had a strong run while China was closed. The US Note future trades neutral, just below the post-Yellen highs and below 128-23+ resistance. We expect a neutral opening for the Bund.

Today’s eco calendar is empty apart from second tier US New Home Sales. ECB Draghi testifies before European parliament, but apart from perhaps some operational details on QE we don’t expect new insights. Yellen’s testimony to the House will likely be a copy of yesterday’s testimony. After yesterday’s comments, we continue to hold our view that the Fed will hike rates in June. Yellen said that a rate hike could occur at any meeting once the “patient” guidance is dropped. Technically, the US Note future broke below the (previous) 128-23+ support (neckline double top), but retested this level following Yellen’s testimony. We expect no break higher (1.94% support in US 10-yr yield). Next key US events are tomorrow’s CPI, next Friday’s payrolls and the March FOMC meeting. The Bund remains in the narrow 157.97-159.54 range. Longer term, we hold our view that ECB QE buying limits upward potential in EMU bond yields.