Appetite for Risk Continues Ahead of Yellen Testimony

Stocks grinded higher with the dollar while Treasuries and swap rates sold off across the curve as traders priced in a higher probability of a rate hike at next month’s FOMC meeting.  Central bank speculation continues to be a major theme and market-participants are hoping for some clarity from officials this week.  There is a full lineup of central bank speakers on tap including ECB President Draghi this afternoon followed by Fed Chair Yellen, Vice Chair Fischer, and NY Fed President Dudley tomorrow.  Financial regulation is the scheduled topic when Yellen testifies before the House Financial Services Committee, but lawmakers are free to ask questions outside of that scope, including on monetary policy.  Arguably the three most influential members of the Fed have the opportunity to reduce confusion in the markets by reemphasizing the message from last week’s FOMC statement (that troubling global conditions have eased and December remains on the table).

Bond King Bill Gross released his latest Investment Outlook today which expressed concern over the current flatness of the yield curve.  Gross argued that a flat curve has harmful effects on lending in credit markets, which will ultimately stunt growth in the US.  A flatter curve is typical in a tightening cycle, but Gross suggested two ideas to encourage a steeper curve: The Fed can either raise its inflation targets, or begin what he dubbed “Operation Switch”, the inverse of the Fed’s “Operation Twist” from 2012.  Gross’ “switch” would entail the Fed selling longer-term Treasuries and buying shorter-term notes in an effort to steepen the curve, which he views as essential to reviving the economy.

US economic data was light with the exception of a disappointing report on the manufacturing sector, but corporate earnings and issuance calendars were quite full.  Economic data picks up steam this week starting tomorrow and culminating with Friday’s all-important non-farm payrolls report.