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How Did US Treasury Yields React to ECB’s Stimulus Announcement?

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Secondary bond market

US Treasury yields jumped across the yield curve for the week ended March 11, 2016, after the European Central Bank (or ECB) president, Mario Draghi, announced a cut in the interest rates in the Eurozone by five basis points to zero in order to boost sluggish inflation rates and to lift the sagging economy.

The intermediate and long-term yields jumped after Draghi said, “the bank doesn’t anticipate it will be necessary to reduce rates further and would instead focus on quantitative easing,” as the market participants now expect that the US economy is strong enough for the Federal Reserve to raise interest rates this year.

From February 11 to March 11, the two-year Treasury yield was up by 33 basis points and ended at 0.97% on March 11 while ten-year Treasury yields surged by 35 basis points and ended at 2.0%.

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ECB’s stimulus package

The key deposit rate was reduced by ten basis points to -0.4% from -0.3%. Interest rates on the main refinancing system also saw a five basis point cut to 0.25% as Draghi sought to take action to rescue the Eurozone economy from low global demand. Banking stocks in the Eurozone countries such as Deutsche Bank AG (DB), ING Groep NV (ING), and Royal Bank of Scotland Group (RBS) rallied after the announcement.

The monthly asset buying program was increased to 80 billion euros from 60 billion euros, above market expectations of an increase to 70 billion. Adding to the monetary policy changes, a series of four targeted longer-term refinancing operations (or TLTRO II) will be launched in June 2016 with maturities of four years. In the past, TLTROs have been successful in creating a funding environment for banks.

Performance of mutual funds and ETFs

As yields on most Treasury securities rose, associated ETFs and mutual funds fell due to the inverse relationship between yields and prices. From February 11 to March 11, the iShares 20+ Year Treasury Bond Fund (TLT) fell 4.6% while the iShares Core US Aggregate Bond (AGG) was down by 0.4%. The Vanguard Long-Term Treasury Fund – Investor Shares (VUSTX) and the MFS Government Securities Fund – Class A (MFGSX) were down by 1.0% and 0.3%, respectively.

Meanwhile, for the same period, ETFs were trading on a higher note across the Eurozone after the ECB chief’s comments. The iShares MSCI Germany Index ETF (EWG) was up by 9.8%. The iShares MSCI Eurozone ETF (EZU) and the iShares Currency Hedged MSCI Eurozone ETF (HEZU) was up by 11.8% and 14.3%.

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