Interest rates are still trending higher and equities are catching a bid this morning after the European Central Bank announced a hawkish shift in monetary policy. The ECB this morning raised interest rates by 25 basis points to 1.25 percent in its first hike since July 2008 to offset inflationary pressures in the eurozone. From the ECB:

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

1. The interest rate on the main refinancing operations of the Eurosystem will be increased by 25 basis points to 1.25%, starting from the operation to be settled on 13 April 2011.
2. The interest rate on the marginal lending facility will be increased by 25 basis points to 2.00%, with effect from 13 April 2011.
3. The interest rate on the deposit facility will be increased by 25 basis points to 0.50%, with effect from 13 April 2011.

The ECB's interest rate hike was expected. Eurozone inflation rose 2.6% year-over-year in the latest read, and the bank responded by saying "strong vigilance is warranted with a view to containing upside risks to price stability." The move makes the ECB the "first of the developed world's major central banks to initiate a cycle of raising rates," according to the Wall Street Journal.

The Bank of England kept its policy rate at 0.5% and the Asset Purchase Facility was steady at £200 billion. The Bank of Japan also kept rates within the 0%-to-0.1% range.

Treasuries were mostly flat overnight in healthy volume, but yields have moved higher since the ECB announced its rate hike.  The benchmark 10-year Treasury note is currently -7/32 at 3.573% (+2.6bps) after backing six basis points for each of the last two days.  The 30-year Treasury, also flat overnight, softened eight basis points Wednesday to 4.59% and is currently -14/32 at 102-03 yielding 4.619% (+2.6bps). The 2s/10s curve has steepened to 273bps wide.

Treasuries have been weakening as inflation hawks on the FOMC board call for the overnight lending rate to rise from its current zero to 0.25% range. Others have considered prematurely ending the quantitative easing program scheduled to conclude this summer. Rising rates would mean that current Treasury coupons are less attractive, which causes a sell-off, particularly among longer-term assets.

Despite benchmarks breaking a key support level at 3.50%, mortgages performed well yesterday in decent trading volume. In his morning note AQ wrote, "I thought for sure currrent coupon yield spreads would move wider when 10s broke 3.50% support…but mortgages didn’t extend and spreads actually tightened thanks to a general lack of loan production supply and fast$ interest in lower dollar prices. Trading volume was above average but only in Class A coupons (Fannie/Greddie 30yrs?), which start the settlement process next Monday. UIC saw better buying ahead of prepays last night, which were once again slow. As far as mortgage rates go, Best Execution is all over the map thanks to the implementation of new originator compensation plans, but rates definitely increased yesterday"

The FNCL 4.5 MBS coupon is currently flat at 101-09.

U.S. equities are modestly up this morning despite the European Central Bank opting to raise rates by 25 basis points to 1.25%. U.S. equities are finding some direction from global stocks. Shares in China and Japan closed 0.22% and and 0.07% higher, while stocks in Hong Kong were flat. The European session is currently mixed, but moves in both directions are marginal. S&P 500 futures are 2.25 points higher at 1,331.25 and Dow futures are 23 points up at 12,367.

Light crude oil jumped 2.66% overnight to $108.84 per barrel as gold prices continue to push record high levels; gold rose 0.15% overnight to $1,460.70.


Key Events Today:

8:20 - Jeffrey Lacker, president of the Richmond Fed, speaks on innovation in a new regulatory environment at the 2011 Ferrum College Forum on Critical Thought, Innovation & Leadership in Roanoke, Virginia.

8:30 - After some holiday and seasonal volatility around the New Year, Initial Jobless Claims has been fairly consistent in reporting a downward trend in the last two months. Weekly claims for unemployment benefits have come in below 400k for three straight weeks and under under 420k for seven weeks. Last Thursday, claims fell 6k to 388k, leaving the 4-week average at 394,250. Economists anticipate 385k for the final week of March.

Last week's survey also showed the number of people continuing to receive claims fall by 51k to 3.714 million - the lowest since October 2008.

11:00- Treasury announces the terms of 3-year, 10-year, and 30-year debt auctions to be held in the following week

3:00 - Consumer Credit began 2011 by rising $5 billion, a fourth straight gain indicating that households were continuing to pay off debt and staying away from excessive new obligations. A consensus forecast wasn't available for the February survey, but economists at BBVA look for a $2.4 billion uptick.

"Given the strong vehicle sales we expect that non-revolving loans which includes auto loans and student loans probably increased at a solid pace in February," said economists at Nomura. "However, weakness in ex-auto consumption is expected to feed into a decline in revolving loans in the month.