The Economy and Bond Market Diary (July 26, 2010)
Treasury bonds sold off modestly this week as sentiment toward global growth prospects improved and the stress tests of European banks turned out benign.
Economic data was generally disappointing this week but the market appears to now be leaning toward the current economic weakness as just a “soft patch” and is becoming more optimistic that growth will reaccelerate. The chart below illustrates the current market quandary: Leading economic indicators have decelerated three months in a row but still remain at a high level. The market is now struggling with whether the odds of a double dip were overestimated and whether those expectations are reversing.
Strengths
- The stress tests of European banks were released on Friday and the results were taken by the market as benign. After the data was released, stocks rallied and bonds sold off.
- The National Association for Business Economics conducted a poll which indicated increased hiring even in the face of slower growth expectations.
- Fed Chairman Bernanke implied the Fed would provide additional support for the economy if needed.
Weaknesses
- Housing data disappointed again with housing starts falling to an 8-month low and existing home sales falling 5.1 percent in June.
- The Bank of Canada raised interest rates, citing strong economic growth and increasing employment.
- Fed Chairman Bernanke, while offering support if needed, also highlighted the “unusually uncertain” environment with downside risk to both employment and economic growth.
Opportunities
- Inflation is unlikely to be a problem for some time. This gives central bankers and other policy makers around the world room for expansive policies.
Threats
- The risk of austerity measures going too far and significantly diminishing economic growth is a real risk.
