Treasurys Strengthen on Yellen Testimony

By Sam Goldfarb Features Dow Jones Newswires

U.S. government bonds strengthened Wednesday as Federal Reserve Chairwoman Janet Yellen said the Fed won't need to raise interest rates as high as previous cycles amid an uncertain inflation outlook.

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In written testimony before the House Financial Services Committee, Ms. Yellen said that "gradual increases in the federal-funds rate" were warranted over time to meet the central bank's objectives of full employment and stable prices. But she added "the neutral level of the federal-funds rate is likely to remain below levels that prevailed in previous decades."

Ms. Yellen also noted uncertainty about "when -- and how much -- inflation will respond to tightening resource allocation," in effect acknowledging investors' focus on the recent softening of inflation despite the presence of a strengthening labor market.

In recent trading, the yield on the benchmark 10-year Treasury note was 2.309%, according to Tradeweb, compared with 2.344% before Ms. Yellen's testimony was released and 2.362% Tuesday. Yields fall when bond prices rise.

Bond investors have "treated this like a very dovish testimony," said Priya Misra, head of global rates strategy at TD Securities in New York.

Ms. Yellen will answer lawmakers' questions Wednesday, potentially altering the interpretation of her initial remarks.

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The bond market has steadied in recent days after a two-week selloff, which was largely driven by anxiety that an improving global economy may allow major central banks to scale back ultraloose monetary policies.

After dropping below 2.2% last month, the 10-year yield closed last week at 2.393%, its highest level since May.

Investors are especially nervous that the European Central Bank could begin tapering its bond-buying program. The Bank of Canada is also expected on Wednesday to raise its benchmark policy rate for the first time in seven years.

Ms. Yellen, in her testimony, reiterated that the Fed plans to start shrinking its $4.5 trillion portfolio of bonds and other assets later this year, but wasn't more specific about the timing.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

U.S. government bonds strengthened Wednesday as Federal Reserve Chairwoman Janet Yellen signaled the central bank would take a cautious approach to tightening monetary policy in the face of an uncertain inflation outlook.

Appearing before the House Financial Services Committee, Ms. Yellen said Fed officials still expect inflation to reach their 2% target, but also noted they were watching the data "very closely" and prepared to adjust their policy if inflation doesn't pick up.

Ms. Yellen's concern about a run of soft inflation data exceeded that shown in other recent public appearances, some analysts said, a change in tone that sent investors scrambling to buy bonds. Inflation is a main focus for bond investors because it erodes the purchasing power of their fixed returns and can lead to higher interest rates, which also hurts prices for outstanding bonds.

Wednesday's rally came after a recent bout of weakness in the bond market. Fearing a broad shift by global central banks away from their longstanding stimulus policies, investors had dumped government debt in recent weeks, lifting the yield on the benchmark 10-year Treasury note to nearly 2.4% from below 2.2%.

On Wednesday, the yield settled at 2.325%, a drop from 2.362% Tuesday and 2.393% at the end of last week. It was the yield's largest one-day decline in nearly a month. Yields fall when bond prices rise.

"The rates market has been looking for something to latch onto," and Ms. Yellen provided it, said Brian Edmonds, head of interest rates trading at Cantor Fitzgerald LP.

Long considered hesitant to tighten monetary policy, Ms. Yellen has appeared more eager in recent months, saying the recent slowdown in inflation was largely attributable to temporary factors. For a while, investors mostly shrugged off such comments, buying Treasurys in the belief inflation would remain low and prevent the Fed from raising interest rates aggressively.

Sentiment shifted at the end of June, however, as officials from other major central banks also suggested they were growing more comfortable with the state of the global economy. That raised the prospect of multiple central banks tightening policy at around the same time, putting downward pressure on bond prices.

Still, investors haven't forgotten about the tepid inflation data. Even before Ms. Yellen's testimony, Treasurys had shown signs of stabilizing this week, a sign investors were ready to re-enter the market with 10-year yield still well below its high for the year.

Helping to offset some of the demand for bonds Wednesday was an auction of 10-year Treasury notes, which got a somewhat weak reception after yields had declined earlier in the day. The sale followed an auction of three-year notes Tuesday. A sale of 30-year bonds is scheduled to take place Thursday.

Further insight into the inflation situation will come soon, with U.S. consumer price data set for release Friday.

"If Friday's numbers suggest that yes, inflation did pick up -- it didn't need to rebound massively, just not disappoint -- I think some of the faith in the Fed continuing to hike this year and next year can come back to the market," said Priya Misra, head of global rates strategy at TD Securities in New York.

Write to Sam Goldfarb at sam.goldfarb@wsj.com

(END) Dow Jones Newswires

July 12, 2017 16:51 ET (20:51 GMT)