The Economy and Bond Market Diary (June 28, 2010)
Treasury bonds rallied this week, sending yields lower by about 10 basis points across much of the Treasury yield curve. Weak housing data and growing concerns over the global economic impact of austerity measures were the primary drivers. The Federal Reserve met this week and met expectations by signaling no change in monetary policy.
New homes sales dropped nearly 33 percent in May to 300,000 units, less than a quarter of their level in May 2005 and the lowest level since records began in 1963. Expiration of the homebuyer tax credit apparently pulled demand forward and the market is suffering without that support.
Strengths
- China relaxed the yuan’s peg to the dollar, essentially allowing it to appreciate. While this is effectively a tightening step for China, it is viewed as a better alternative than raising interest rates. The timing was also favorable from a political standpoint, as the G-20 meeting of large economies is being held this weekend in Toronto. Many nations participating in the meeting have urged China to allow appreciation.
- Global steel output rose 29 percent in May and now stands 10 percent higher than May 2007, before the global economic crisis.
- The University of Michigan Consumer Confidence Index rose to the highest level since January 2008.
Weaknesses
- May new home sales hit a record low and existing home sales also disappointed, falling 2.2 percent in the month. Housing is not providing any basis for the economic rebound.
- Austerity measures are all the rage around the world, including the United Kingdom, Germany and Japan. The measures proposed are often aggressive cost cutting or tax increases that threaten the near-term economic recovery.
- Durable goods in May declined 1.1 percent, better than expected but still down sharply.
Opportunities
- Inflation is unlikely to be a problem for some time and this gives central bankers and other policymakers around the world room for expansive policies.
Threats
- The risk of austerity measures going too far and significantly diminishing economic growth is real.
- Concerns about a full-blown credit crisis have probably diminished, but still cannot be ruled out.
