Over the week 10-year US yields saw another 13 bps decline in yields, closing on Friday at 1.77%, with US Treasuries recording the best start to a year since 2008. Treasuries were boosted by dovish comments from Janet Yellen and concerns about a weak global economy which offset an otherwise respectable jobs report on Friday.
After a couple weeks of hawkish comments from Fed members, a cautious approach in adjusting policy was the theme of Janet Yellen’s speech which she delivered at the Economic Club of New York last week. She highlighted that a cautious stance is “warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric”. She noted that domestic inflation is “somewhat more uncertain” adding that although there have been signs of pick-up, US economic indicators remain “somewhat mixed”. These comments reinforce Yellen’s comment a couple of weeks ago which indicated she is unconvinced by the strength in the core PCE data of late stating, "I haven't concluded that we have seen any significant uptick that will be lasting."
With increasing global uncertainty, Yellen even discussed the central bank’s “considerable scope” to ease if the economy falters, “we used them effectively to strengthen the recovery from the Great Recession” and would do so again, adding that “only a modest degree of additional stimulus” can be provided.
In contrast, Friday’s non-farm payroll data showed another month of solid job gains: the US economy added 215,000 jobs in March slightly ahead of expectations. Average hourly earnings edged up to 2.3% yoy from the prior reading of 2.2% while average hours worked was unchanged from the prior month’s figure of 34.4 hours.
It came as little surprise to us that the FOMC has recently scaled back its 'dot plot' to two rate rises from four in 2016, although even this still looks optimistic. The FOMC’s forecasts are based on the assumption that ‘economic headwinds’ will fade and a gradual increase in the neutral rate will then be required.
Nevertheless, US growth remains patchy and uneven; aside from the obvious weakness in the manufacturing sector, US real median household income has declined since 2007 reflecting rising income inequality and ‘external conditions’ have been unsupportive. Added to which we have the issue of declining working-age populations in many developed and some developing economies (notably China) which will act as a significant headwind to global economic growth in the decades ahead.
This implies the Fed can afford to be 'patient' in raising rates. Downward revisions to the US’s potential output growth combined with ‘external headwinds’ and a Fed acting ‘ahead of the curve’ should support Treasuries at the long end. This should also boost demand for high quality quasi-sovereign issues from 'wealthy nations', which still offer a generous spread over Treasuries.