The Economy and Bond Market Notebook
Treasuries rallied sharply this week as the flight-to-quality trade accelerated. The yield on 10- and 30-year treasuries both fell by about 25 basis points this week.
Macro factors have been critical in driving the market recently. The chart below depicts the three-month rate which banks lend to each other called the Libor rate. The rate is at the highest level since July but is well below the extremes experienced during the height of the financial crisis early last year. The message here is that concern that a significantly negative outcome could occur but the risk implied by this indicator is signaling low probability of that happening.
Strengths
- Bonds rallied sharply this week as investors preferred the safety of high quality U.S. denominated debt.
- Both the Consumer Price Index (CPI) and the Producer Price Index (PPI) fell slightly in April, giving the Fed plenty of room to maneuver.
- Japan’s GDP rose 4.9 percent during the first quarter and has now risen for four consecutive quarters.
Weaknesses
- The global growth outlook remains a wildcard and the market’s reaction this week appeared to be driven more by this assessment than by sovereign debt default fears.
- Mortgage delinquencies rose to a record high in the first quarter, hitting 10.1 percent.
- Building permits fell 11.5 percent in April, a sign that the housing market may struggle without government incentives.
Opportunities
- The current environment appears similar to 2008 in many ways but there are also crucial differences. The economy is recovering and global economic growth still looks like the most likely outcome. In addition, while some fear/risk indicators are elevated they are nowhere near the panic levels seen during the past crisis.
Threats
- Until the Greek situation is resolved with some degree of certainty, the market will be at the whims of macro risk factors.
- Concerns of a full blown credit crisis have probably diminished some but can not be ruled out.
