Balance sheet growth key at first Fed policy meeting

Core bonds fell prey to some profit taking yesterday on the coronavirus-driven rally since early last week. Hong Kong travel restrictions caused a final hiccup before investors decided to take some chips off the table. Stock markets recovered with the US outperforming Europe. Mixed-to-better US eco data and a weak US Treasury 7-yr Note sale contributed to a slight underperformance of US Treasuries vs German Bunds. The US yield curve bear steepened with yields ending 2.2 bps (2-yr) to 5.5 bps (30-yr) higher. The German curve shifted in similar fashion with yields rising 0.3 bps (2-yr) to 4.6 bps (30-yr). 10-yr yield spreads vs Germany narrowed slightly with Greece (-3 bps) and Italy (-5 bps) outperforming. Greece successfully raised €2.5bn via a syndicated 15-yr (!) bond deal which drew nearly €19bn in bids.

Most Asian stock markets are upwardly oriented this morning even if the coronavirus death toll keeps rising. Hong Kong underperforms in a catch-up move after returning from a regional holiday. Core bonds tread water near yesterday's correction lows.

Today's eco calendar is all about the Fed's first policy meeting of the year. Last year's final dot plot showed near-consensus on keeping policy rates stable throughout 2020 while the Fed completes its internal policy review. Recent events, speeches by governors, eco data and inflation figures suggest no alternation to this scenario even if short term money markets discount a 25 bps rate cut by the end of the year. Fed Chair Powell could be grilled on the central bank's balance sheet though at the Q&A session. Since September 2019, the balance sheet rose from $3.8tn to $4.1tn as the Fed first introduced (term) repo operations and later Treasury bill purchases ($60bn/month) to stem problems in the US repo markets originating from falling reserve levels. It's an open question on how the US central bank sees these emergency tools evolving. Will they become a permanent policy feature (e.g. standing repo facility) and/or will bill purchases be phased out during Q2? Fed balance sheet growth in the past proved to be an important driver of risk sentiment. Q4 earnings remain a wildcard for trading, while the debate around blocking impeachment witnesses in President Trump's trial could start grabbing some attention as well. A vote will probably be held on Friday.

Technically: core bond yields failed to take out resistance levels at -0.18% (July high)/-0.15% (38% retracement of Feb '18 – Sep '19 decline) for the German 10-yr yield and 1.94% for the US 10-yr yield. The Chinese coronavirus took markets hostage via risk aversion, pulling core bond yields below first support. We hold our view that this won't be a lasting market theme.

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