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.

Frank Holmes is CEO and chief investment officer of U.S. Global Investors, Inc., and a Toronto, Canada native, which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure. The company’s funds have earned more than two dozen Lipper Fund Awards and certificates since 2000. The Global Resources Fund (PSPFX) was Lipper’s top-performing global natural resources fund in 2010. In 2009, the World Precious Minerals Fund (UNWPX) was Lipper’s top-performing gold fund, the second time in four years for that achievement. In addition, both funds received 2007 and 2008 Lipper Fund Awards as the best overall funds in their respective categories. Mr. Holmes was 2006 mining fund manager of the year for Mining Journal, a leading publication for the global resources industry, and he is co-author of “The Goldwatcher: Demystifying Gold Investing.” He is also an advisor to the International Crisis Group, which works to resolve global conflict, and the William J. Clinton Foundation on sustainable development in nations with resource-based economies. Mr. Holmes is a much-sought-after conference speaker and a regular commentator on financial television. He has been profiled by Fortune, Barron’s, The Financial Times and other publications. Read more from the author/contributor here.

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