US yields fall and flatten even as equities rise strongly. US Fed sees full employment and wage gains but no special concern over inflation. The pace of normalisation gets trader attention

By Nick Smyth

US equities ended the week higher while US bond yields fell and the yield curve flattened. 

Ahead of new Fed Chair Powell’s testimony this week, the Fed’s semi-annual Monetary Policy Report noted that US wage growth was “moderate, and didn’t signal any heightened concern about inflation risks.  The NZD underperformed on Friday and sits just below 0.73. 

US equity markets rose strongly on Friday, with the S&P500 up 1.6% and the NASDAQ up almost 1.8%.  The negative correlation between US bond yields and equities continued, with the 10 year Treasury yield falling 6bps to 2.87%.

The Fed’s semi-annual Monetary Policy Report was released on Friday ahead of new Chair Powell’s testimonies to House and Senate committees this week. The Report noted the US labour market “appears to be near or a little beyond full employment” but described wage gains as “moderate” and didn’t signal any heightened concern about inflation. 

Powell’s comments this week will be important in shaping the market’s expectations for the March FOMC meeting.  While a rate hike is fully-priced for March, the focus will be on the Fed’s ‘dot plot’, which shows Fed members’ rate projections for the coming few years.  The Fed’s last projections, in December, showed a median expectation of 3 hikes for 2018, similar to current market pricing.

The market will be particularly focused on whether Powell has anything to say on the possibility of more than 3 hikes this year.  On Friday, San Francisco Fed President Williams said “three to four” rate increases was the “right path”.  The 2 year yield fell 1 bp Friday, in contrast to the 6 bp fall in the 10 year yield, causing the US yield curve to flatten.

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