Bond Report: Treasury yields retreat after ECB lays out timetable for end to easy-money policies

Treasury yields extended their fall early Thursday in New York after the European Central Bank issued a timetable for the end of its easy-money policies.

The ECB said it would end its monthly asset purchases in December but wouldn’t raise interest rates “at least through the summer of 2019.”

This follows the Federal Reserve’s decision on Wednesday to lift interest rates, as expected. The U.S. central bank also signaled that it would tighten monetary policy at a slightly faster clip than had previously been anticipated, with the domestic economy growing steadily.

What are markets doing?

The 2-year note yield TMUBMUSD02Y, -0.16% the most sensitive to shifting interest-rate expectations, shed 2.5 basis points to 2.557%. The 10-year Treasury note yield TMUBMUSD10Y, -0.96% fell by 4.4 basis points to 2.935%, while the 30-year bond yield TMUBMUSD30Y, -0.99% gave up 4.9 basis points to 3.054%.

Wednesday’s rate-hike decision has flattened the yield curve, the spread between short-dated and longer-dated government debt. One measure of that span, the differential between 2-year and 10-year Treasurys, stands at 37.6 basis points, or 0.376 percentage point, representing the tightest spread since 2007.

The yield gap between the five-year note TMUBMUSD05Y, -0.66% currently at 2.804 and the 30-year bond, another popular gauge of the curve’s slope, narrowed to 24.8 basis points, also marking its flattest reading in more than a decade.

Measures of the yield curve, a closely watched line plotting yields across all Treasury maturities that tends to slope higher because investors demand richer rates for lending for a longer period, is closely monitored by Wall Street because inversions, in which short-dated yields move above long-dated ones, have served as accurate predictors of recessions.

Bond prices rise as yields fall.

What’s driving Treasurys?

The bond market rallied after the European Central Bank indicated that it would end its monthly asset purchases in December and signaled that it would join the Federal Reserve in tightening its benchmark interest rates at least until the summer of 2019. On September, the purchases would slow to a €15 billion ($17.6 billion) monthly pace, until December when the bond-buying program would be halted altogether.

See: ECB aims to end bond-buying program by end of 2018

An end to the ECB’s bond-buying program should allow longer-dated Treasury rates to lift off, by drawing investors back into eurozone debt as their yields rise and become more attractive, market participants have said. However, investors responded more strongly to the ECB’s “dovish” forward guidance suggesting rates would stay low for longer than had been expected.

Read: The ECB, not the Fed, is the match that will spark bond market volatility: analyst

The ECB decision helped to undo the selloff on Wednesday when Fed officials raised the benchmark federal-funds rate by a quarter-percentage point to a range between 1.75% and 2% and raised estimates for the pace of growth and inflation, which can chip away at a bond’s fixed payments.

Fed Chairman Jerome Powell cited an economy that was “in great shape,” during a news conference following the policy update, however, a fall in the yields of longer-dated bonds suggest that investors may have a more muted outlook for economic growth currently approaching its ninth year of expansion amid concerns about President Donald Trump’s trade policy. The latest increase will bring the rate increases for this year to four, up from a projection of three increases at their March meeting.

“Growth is strong. Labor markets are strong. Inflation is close to target,” Powell said at the news conference.

Against the backdrop of uncertainties around U.S. trade policy and the growth picture, however, some market participants took the Fed statements as underlining questions about the long-term economic prospects.

What did market participants say?

“By way of a forward commitment, the ECB said rates will be unchanged (negative) until at least the summer of 2019—this was the biggest ‘surprise’ and read dovishly. The initial price action was negative for bunds and Treasurys, but both markets have firmed on the realities of a lower-for-longer stance on overseas monetary policy,” said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.

“Despite this near-term confidence in the economic outlook, Chair Jerome Powell used the press conference to stress the uncertainty around future policy developments. He frequently cited ‘wide uncertainty’ around “unobserved variables” and reiterated the need to focus on incoming data,” wrote Credit Suisse analysts in a Thursday research note.

How are other assets doing?

The yield for the 10-year German government bonds TMBMKDE-10Y, -8.11% a proxy for the health of the eurozone economy, fell 4.7 basis points to 0.437%, according to Tradeweb data.

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