US Treasuries very modestly lower on Yellen

Rates

Yesterday, trading was uneventful till the Yellen testimony (see Sunset report for more details). Yellen’s remarks were broadly in line with earlier comments. The Fed is in no hurry to start raising rates and doesn’t want to use monetary policy to reign in exuberance on markets. The reactions on Yellen’s testimony (see below for detailed review) were very modest. US Treasuries made some modest swings, but closed with some small losses. The shorter end underperformed slightly, as at the margin a rate hike may come a bit earlier than hitherto expected. In yield terms, the 3‐yr added around 2.3 bps, the 5‐yr 1.5 bps while the 10‐yr was flat and the 30‐yr yield marginally higher. Equities initially fell, but ended the session little changed. The NASDAQ lost 0.54% on remarks about valuation in biotech and social‐media stocks (see lower). The dollar gained moderate ground, as EUR/USD fell to 1.3570 from 1.3610.

Today, the US eco calendar remains interesting with the PPI inflation data, industrial production and the NAHB housing market indicator. After a dip in May, it will be interesting to see whether PPI inflation will resume it uptrend in June. The consensus is looking for an increase in the final demand PPI by 0.2% M/M. The annual reading is however forecast to slow from 2.0% Y/Y to 1.9% Y/Y, as the strong increase in June last year will fall out of the calculation. We believe therefore that the annual reading might ease even a bit more. Also in the US, industrial production is forecast to have increased for a second straight month in June; although the pace of growth is expected to have slowed, from 0.6% M/M in May to 0.3% M/M in June. Hours worked in the manufacturing sector stayed unchanged in June, following a strong increase in May. We believe that also output growth might be a bit slower. Finally, the NAHB housing market index is forecast to pick up slightly further, from 49 to 50, following a substantial rebound in June. We see risks for an upward surprise after strong housing data of recent, which suggests that the sector is regaining strength following a dip in the first half of the year.

Ms. Yellen gave a balanced reading of the economic health of the US economy, but stressed that “considerable uncertainty” about the outlook could lead to interest rates rising earlier or later than expected. There was a small change compared to her remarks at the June press conference (before the strong June payrolls), implying that if the labour market keeps improving at the current pace, that might be enough for the Fed to hike rates earlier than expected. In June she said that such earlier move may happen if the economy proves to be stronger than anticipated. However, she still sees a lot of slack in the labour market and economy. Amongst other the weaker labour market participation may be a kind of hidden slack or unemployment, while also subdued wages point in that direction. However, she said that considerable uncertainty means the Fed needs to be very cautious. Some quotes: “We have seen in the past false dawns.” “The pace of economic growth bears close watching”. “The recovery is not yet complete”. “In particular, housing sector has shown little progress.”
Concluding, the Fed is in no hurry to start raising rates and wants more signs the recovery is firmly anchored. We look closely to the labour and housing markets for signs the recovery is complete.

On financial stability, Yellen repeated that there was no need to increase rates to tackle financial instability as the central bank has other tools at its disposal. She wants to have a resilient financial system that can cope when asset bubbles bust, rather than popping bubbles via higher rates. Only in extreme situations monetary policy may have a role to play. She acknowledged that there were pockets of over‐optimism in markets and signalled out corporate bonds as well as very low volatility in markets, together with an easing of the terms and conditions in the leveraged loan market. The monetary report that accompanied her speech stated that valuations in some smaller biotechnology and social media firms were stretched, as well as small company stocks in general.

The German Finanzagentur taps the on the run 10‐yr Bund (1.5% May2024) for €4B. The relatively low amount on offer should be manageable for investors to digest. At the previous four Bund auctions, total bids averaged €4.75B. The bond traded stable going into the auction and trades a tad cheap at the 10‐yr sector of the German yield curve. Following the auction, Germany will have completed around 60% of this year’s expected issuance. The auction will be supported by bond redemptions from Austria (€9.5B) and the Netherlands (€12.5B).

Overnight, most Asian markets trade slightly positive despite small WS losses. Chinese Q2 GDP slightly outpaced expectations, accelerating to 7.5% y/y from 7.4 y/y in Q1. Industrial production data and retail sales were also close to expectations but overall the data were hopeful. KC Fed George said that the economy, with a strengthening labour market and rising inflation, is ready for a more‐neutral rating environment. However, after Yellen’s comments and given the fact that her views are well‐known, the market didn’t react. This morning, the US Note future even regains most of yesterday’s minor losses. It does show though the debate is heating up in the FOMC.

Today, attention again goes to the US with production data, NAHB housing index (recovery housing market is important for Fed) and the second part of Yellen’s testimony. We think that eco numbers will be mixed (see above) and that Yellen will stick to yesterday’s line. Therefore, the impact on bond markets should be neutral. Wildcards for trading remain the Banco Espirito Santo case (Espirito Santo International’s main unit is preparing to file for creditor protection) and the deteriorating situation in armed conflicts (Ukraine/Gaza Strip).