This Great Graphic, constructed on Bloomberg, shows the U.S. 2-Year yield since the start of the month. The sharp rise in yields on February 6 was in response to the employment data and the recovery in hourly earnings. Yields had slowly firmed through Wednesday when they reached almost 69 bp.
The dovish read to the FOMC minutes pushed the yield back down into the range seen on the jobs report. There was a little more follow through Thursday.
From a technical perspective, the pullback stopped where is should -- if this was a technical correction. The 50% retracement (blue horizontal line) is just below 57 bp and the 61.8% retracement (lower green horizontal line) is a touch underneath 54 bp.
We suspect the market exaggerated the dovish tone to the FOMC minutes and would not be surprised to see Yellen sport a less-dovish view when she testifies before Congress next week. Many participants wrongly (we think) see Yellen as a dove. The chair by definition is the center. There are some members more dovish and some more hawkish.
We argue that the policy signals from the Fed are generated by the Fed's leadership -- Yellen, Fisher and Dudley. The signals from them is still consistent with a mid-year hike. We believe that the tapering has proved to be the model the Fed is using for lift-off. They said what they were going to do -- and they did it.
Some hawks may wish the Fed would hike rates in March, but that's not likely. Some doves may hope the Fed won't raise rates this year. Yellen strikes a middle ground. By midyear, the continued improvement in the labor market will likely offset the fact that the journey toward the inflation objective has stalled. However, the Fed's leadership recognizes that the decline in oil prices is transitory and does have some knock-on impact on core inflation measures. We do not think that the return to trend growth in the US after the strong performance in April-September is a significant obstacle to a Fed rate hike.
We also think the Fed leadership recognizes that the emergency monetary conditions that were essential to support the economy and prevent a Great-Depression-like scenario are no longer needed. This does not mean that the economy is firing on all cylinders or that rates need to be significantly higher.
It simply means that the patient no longer needs the emergency room.