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The Bond Column

Treasuries Rally Despite Obvious Bullish Catalyst
Updated: 2017-07-24, 08:55:37 ET
Analyst: David Kelland

U.S. Treasury yields continued to move lower from their mid-July highs this week. The U.S. economic data releases were limited to regional manufacturing surveys and the Housing Starts report. The Empire Manufacturing Index fell 10 points to 9.8 in July ( consensus 13.0) and the Philadelphia Fed Index fell 8.1 points to 19.5 ( consensus 22.0). U.S. housing starts totaled 1215K in June ( consensus 1122K) and the prior reading was revised up by 30K. Building permits beat estimates too.

The biggest event for the week was ECB Governing Council's rate decision. While the GC kept monetary policy on hold, as expected, policymakers also left the language referring to the possibility of expanding or extending the asset purchase program if inflation dynamics deteriorate. A large minority percentage of analysts had expected that language to be removed.

All eyes in eurozone fixed-income markets are on how the European Central Bank will adjust that program over the next couple of months. Since the EUR60 bln of monthly asset purchases are slated to complete at the end of 2017, investors expect at least an announcement to extend the program. Most analysts, however, see a tapering of monthly total as the eurozone economy recovers and the APP runs up against self-imposed limits for its purchases of German debt (the issuer limit). With the Fed's unwinding of its balance sheet largely clear now except for the start date of the process, the ECB's program is the real uncertainty.

In related markets, oil prices fell somewhat but equities rallied. The U.S. Dollar Index fell to a one-year low of 93.85 this week. A weaker dollar should be stimulative for U.S. exports over the medium term and should also mean that higher import prices lead to slightly faster inflation.

The price action was a bit suspicious this week though. The fundamentals did not seem to warrant such a sharp decline in yields. The FOMC meets this coming Tuesday and Wednesday and expectations for the meeting are that nothing will happen. On Friday, the first official estimate of Q2 GDP will be released. The market's reaction to those two events could be a good indicator of whether we're headed to the March high yields or the June lows.

- David Kelland,