The Economy and Bond Market Radar (January 30, 2012)
Long-term Treasury yields fell sharply this week as once again the schizophrenic market gyrates up one week and down the next, which is what we have experienced since mid-November.
The Federal Reserve surprised the market this week with a news release that details the “central tendency” of thinking from Fed officials on the direction of federal fund rates. What surprised the market was the Fed’s statement that current economic conditions “are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.” That is well beyond current expectations and was a catalyst for appreciation.
Easy monetary policy on a global basis and a reduction in risk perception in Europe has allowed bonds to rally, not only here in the U.S. but also in Europe. As can be seen in the chart below, Italian 10-year bond yields have rallied significantly from more than 7 percent to below 6 percent in less than three weeks.
Strengths
- The Federal Reserve guided the market to expect continued easy monetary policy for roughly the next three years.
- Durable goods orders rose 3 percent in December as manufacturing indicators are signaling a rebound in activity.
- In another indicator that global manufacturing is improving, eurozone composite PMI rose back into expansion territory.
Weaknesses
- Fourth quarter GDP rose 2.8 percent. While this was the best quarterly showing since the second quarter of 2010, it did trail expectations of at least 3 percent growth.
- New home sales fell 2.2 percent in December and only 302,000 new homes were sold during 2011, the worst performance since 1963.
- The Conference Board index of leading economic indicators index (LEI) rose 0.4 percent but was short of expectations.
Opportunities
- The Federal Reserve is in no hurry to raise rates and appears very comfortable with the current inflation situation. This means the Fed is likely to maintain a very easy monetary policy for some time.
Threats
- If the weekly oscillating trading pattern over the past couple of months is any indication of market direction, bonds could see a modest sell-off next week.
