Yellen Signals Economy is On Track for Rate Hikes, Prompting Selloff in Treasurys

In prepared testimony to the Senate Banking Committee this morning, Fed Chair Janet Yellen delivered hawkish comments in support of gradual rate hikes given the US economy’s current growth path.  Referencing the expectation for a further tightening in the labor market and inflation increasing to the 2% target, Yellen stated that “waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.”  When questioned about the potential for a tightening in March, Yellen did not signal in either direction, but indicated that every meeting is live and “at our upcoming meetings, the committee will evaluate whether employment and inflation are continuing to evolve in line with these expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.”  She also confirmed that FOMC decisions would be based on economic trends, not speculation over the future of fiscal policy.  Discussing the eventual shrinking of the Fed’s $4.5 trillion balance sheet, Yellen explained that the intentions are to not use the balance sheet as an “active tool of monetary policy management,” but to contract the portfolio in an “an orderly process,” with an ending balance of solely Treasury securities (i.e. eliminating mortgage debt).  US Treasurys sold off shortly into Yellen’s prepared remarks, as yields/swap rates increased for the fourth consecutive session, up 3-6 bps across the curve.  US dollar investors welcomed today’s hawkish rhetoric, with the greenback rising to a three-week high against a basket of major currencies.  All three major US stock indices traded sideways for the greater part of the trading session before posting gains of 0.2%-0.3% and recording new all-time highs.

Producer Prices Jump
In an otherwise light day for economic news, the Producer Price Index (PPI) reported a larger-than-expected rise for the month of January at +0.6%.  Last month’s reading stands as the highest in more than four years, boosted by gains in raw material costs.  The PPI figure climbed 0.3% higher than had been projected, also driven by surging energy prices and a modest increase in services readings.  Excluding food, energy, and trade services, monthly PPI recorded a 0.2% advance.

Euro-Area Growth Revised Lower
In the final quarter of 2016, gross domestic product was revised to a 0.4% rise in the Euro-area, a touch weaker than the 0.5% initially reported.  GDP growth in Germany (+0.4%), Italy (+0.2%), and the Netherlands (+0.5%) fell short of expectations, while output in Greece actually contracted 0.4% where median forecasts had called for a 0.4% advance.  Germany’s fourth quarter GDP was bolstered by domestic demand, notably government spending and construction, but the nation’s trade deficit weighed down the headline figure.  Growth in Italy was also hindered by international trade, offsetting strong industrial production which remained steady in the face of the recent political turmoil and Italian banking struggles.  The Dutch economy managed to benefit from robust foreign trade, recording its 11th consecutive quarter of growth at +0.5% and bringing the nation’s annual growth to its strongest level in more than eight years.