Good day. Rising Treasury yields have sharpened investors' focus on Fed Chairman Jerome Powell’s semiannual report on the economy and monetary policy to Congress, which starts with his appearance before a Senate Committee at 10 a.m. ET. Any comments he makes on bond-market dynamics could offer hints on the outlook for the Fed's asset buying over the remainder of the year. Meanwhile, the spread between the two-year Treasury yield and a key interest rate set by the Fed is the narrowest since the depths of the coronavirus market selloff, a potential sign of financial-system stress.

 Now on to today’s news and analysis.

The two-year Treasury yield, which closed Monday at 0.113%, is 0.013 percentage point above the interest rate on excess reserves, or IOER. It traded as low as 0.105% earlier in February. The Fed pays banks on the reserves held above and beyond those required by central-bank regulatory policy as part of its effort to maintain liquidity in the financial system.

The spread between IOER and the two-year yield has typically been above 0.05 percentage point since the Fed cut the rate to its lowest level ever in March. Traders said the shrinking of this spread reflects appetite for short-term debt as investors gobble up safe assets and park their cash. It also highlights a key tension point in financial markets: to what extent is Fed support for markets taking asset prices to unsustainable levels, and how vulnerable does that leave bond markets and other areas exposed to sudden reversals.

Federal Reserve officials don’t appear to share some market participants’ concerns about rising bond yields. Several central bankers in recent days have framed the increase in longer-term yields as a sign of economic success and not a source of worry. Their comments show they view the rise as an expression of confidence the economy will continue to recover from the coronavirus pandemic. Read more.

Time N/A: National Bank of Hungary releases policy statement
10 a.m.: Fed’s Powell testifies on monetary policy before Senate Banking Committee
12:30 p.m.: Bank of Canada’s Macklem gives speech via videoconference
8 p.m.: Reserve Bank of New Zealand releases policy statement and rate decision

9:30 a.m.: Bank of England’s Bailey, Broadbent, Vlieghe and Haskel testify before Treasury Select Committee on February monetary policy report
10 a.m.: U.S. Commerce Department releases January new-home sales; Fed’s Powell testifies on monetary policy before House Financial Services Committee
10:30 a.m.: Fed’s Brainard speaks virtually on the Fed's maximum employment mandate to Harvard University class
1 p.m.: Fed’s Clarida gives virtual speech on economy and monetary policy at U.S. Chamber of Commerce chief economist committee meeting
4 p.m.: Fed’s Clarida gives virtual speech on economy and monetary policy at American Chamber of Commerce in Australia webinar

Changes in fiscal policy have a complicated effect on how households assess the outlook for inflation, according to a new paper made public Monday by the National Bureau of Economic Research. “We find that information about the current debt or deficit levels has little impact on inflation expectations but that news about future debt leads them to anticipate higher inflation, both in the short run and long run,” write Olivier Coibion, Yuriy Gorodnichenko and Michael Weber. “News about rising debt also induces households to anticipate rising spending and a higher rate of interest for government debt.” The paper arrives amid a massive surge in government spending in response to the coronavirus pandemic and as market concerns about future inflation increase. The paper suggests that if the public takes on board how much red ink is on the government's books, inflation expectations should start to rise. That is a good thing for the Federal Reserve as it wants higher inflation, but it is uncertain how well that process can be managed to ensure price pressures don't spiral out of control. 

—Michael S. Derby

Federal Reserve Chairman Jerome Powell makes his semiannual appearance on Capitol Hill this week. Investors have a few questions, and so should Members of Congress, The WSJ Editorial Board writes, focusing its attention on rising bond yields. "Mr. Powell has gone to extraordinary lengths to keep yields low, so how does he view these recent bond movements? Is this healthy, and is he content for investors to make their best guesses about the recovery? Or does he intend to fight investors, perhaps with some version of Japanese-style yield-curve control that would set rates by fiat at longer maturities?"

• The U.S. economy gathered momentum in January driven by stronger consumption and housing data, the Chicago Fed said, noting its Chicago Fed National Activity Index increased to 0.66 from a revised 0.41 in December, suggesting the economy grew above trend and at a quicker pace than the previous month. (Dow Jones Newswires)
• The Leading Economic index for the U.S. rose 0.5% from December to 110.3 in January, marking its ninth straight monthly rise, according to The Conference Board, which expects the U.S. economy to expand by 4.4% this year after a 3.5% contraction in 2020. (DJN)
• Manufacturing activity in Texas continued to grow in February despite the severe winter storm keeping many businesses shut, with the Federal Reserve Bank of Dallas’ production index of the Texas Manufacturing Outlook Survey rising to 19.9 from 4.6 in January. (DJN)
• German business sentiment improved noticeably in February, the Ifo Institute said, noting its business-climate index came in at 92.4 points for the month compared with an upwardly revised 90.3 points in January. (DJN)
• Business sentiment in Belgium rose in February for the third consecutive month, according to the National Bank of Belgium, which said a sentiment gauge increased to minus 4.4 from minus 7.5 in January. (DJN)

This newsletter is compiled by James Christie in San Francisco and Ed Ballard in London. 

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