Yellen says interest rates 'would not have to rise all that much further to get to a neutral policy stance'
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Treasury yields extended a decline Wednesday after the release of Federal Reserve Chairwoman Janet Yellen's prepared congressional testimony showed the central bank was looking to taper its balance sheet but that the prospect of an additional rate hike would depend on how inflation evolved.
The 10-year treasury yield slumped 3.7 basis points to 2.313%, the largest decline in a month, after falling as low as 2.304%. Bond prices move inversely to yields.
The two-year note's yield lost 2.8 basis points to 1.351%, also its sharpest fall close to a month, while the 30-year bond slipped 3.1 basis points to 2.906%.
See: Live blog and video of Yellen's testimony before house panel (http://blogs.marketwatch.com/capitolreport/2017/07/12/live-blog-and-video-of-yellens-testimony-before-house-panel/)
Yellen appeared before the House Financial Services Committee as part of her semiannual testimony about monetary policy in front of Congress.
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Read: Republicans to press Yellen on Fed plans to reduce its outsize role on U.S. economy (http://www.marketwatch.com/story/republicans-to-press-yellen-on-fed-plans-to-reduce-its-outsized-role-on-us-economy-2017-07-11)
In her prepared remarks, she said that the central bank was focused on cutting its $4.5 trillion balance sheet this year, but did not commit to a date of the next interest-rate increase, saying she expected a "gradual" increase in interest rates in the next few years. Yields fell as traders interpreted her written testimony as dovish in part because Yellen showed concerns over the months of weakening inflation.
"I think she's being overly cautious here," said Tom di Galoma, managing director of Treasurys trading at Seaport Global Securities.
Her comments are largely in line with recent speeches from Fed. Gov. Lael Brainard (http://www.marketwatch.com/story/brainard-supports-balance-sheet-drawdown-but-on-fence-over-rate-hikes-2017-07-11) and Philadelphia Fed President Patrick Harker (https://www.wsj.com/articles/feds-harker-says-slowing-inflation-gives-him-pause-on-raising-rates-1499786821), who have both said the Fed could pause the next hike to its benchmark short-term interest rate if the inflation picture deteriorates.
The personal consumption expenditures, or PCE, price index, the Fed's preferred measure of inflation, fell to a 1.7% annual rate in April from a five-year high of 2.1% in February, below the central bank's long-run target of 2%.
Yellen also said a so-called neutral rate, the long-term resting point for the fed-funds rate, was "quite low by historical standards," so it wouldn't have to rise much higher to reach that level. Di Galoma pinpointed this remark as "distressing to the marketplace," as investor perceptions were tilted toward the view that rates would have to head much higher to settle at the neutral rate.
"This has got the market in a rally formation, as you're close to only one or two rate hikes to the end of the tightening cycle in her view," said di Galoma.
But Treasury yields pared some of their earlier gains after analysts said bond investors overreacted. Investors had taken Yellen's comments "drastically out of context" and ignored the part of her remarks saying the factors keeping a lid on the neutral rate should diminish, said Tom Porcelli, chief U.S. economist for RBC Capital Markets.
Also see: Reacting to Yellen, traders may get to right place for wrong reason (Reacting%20to%20Yellen,%20traders%20may%20get%20to%20right%20place%20for%20wrong%20reason)
In economic data, the Fed released its Beige Book (http://www.marketwatch.com/story/feds-beige-book-says-worker-shortage-limits-hiring-2017-07-12), a collection of anecdotes that paint a picture of the overall economy. Like previous editions, it reported that the economy was experiencing tight labor slack as business owners had trouble finding qualified workers for vacant positions. The unemployment rate is now at 4.4%, near a 16-year low.
Kansas City Fed President Esther George, a nonvoting member, said she wanted the central bank to start the process of unwinding the balance sheet "in the near future." One of the most hawkish members in the central bank, her comments made no dent on trading as she was widely expected to push for a normalization of Fed's holdings of Treasurys and mortgage-backed securities.
Elsewhere, the yield for the 10-year German benchmark note, or the bund, fell 4 basis points to 0.507%, paring the gains made since the mini-taper tantrum sparked by hawkishly interpreted comments from European Central Bank President Mario Draghi. The yield decline highlighted the close relationship between global bond markets as investors find it easier to arbitrage differences in interest rates across the world.
(END) Dow Jones Newswires
July 12, 2017 16:21 ET (20:21 GMT)