The Economy and Bond Market Diary (August 23, 2010)
Treasury bonds rallied for the fourth week in a row as the market reacted to weak employment data, the potential for additional quantitative easing and what that implies for inflation.
The chart on the right shows the 10-year Treasury bond, which is now at the lowest level since March 2009 and is potentially sending an ominous message about the prospects for growth and inflation over the next six to 12 months.
Last week the Federal Reserve also announced its intention to maintain its quantitative easing bias by using the proceeds of maturing mortgage and Treasury securities to finance additional purchases of Treasuries. This week it acted on those intentions by purchasing $6.16 billion of Treasuries. The Fed also committed to keeping interest rates near zero for an extended period.
Strengths
- Mortgage rates hit a fresh new low of 4.42 percent, the lowest level since records began 39 years ago. In a related note, refinancing activity jumped 17 percent to the highest level in more than a year.
- Industrial production surprised on the upside in July, rising 1 percent.
- Leading economic indicators rebounded modestly this month, rising 0.1 percent.
Weaknesses
- Initial jobless claims continued to rise and are at the highest levels since November 2009 as the economy struggles to generate employment growth.
- Housing remains weak, even with low interest rates. Housing starts rose 1.7 percent, but much of this was driven by a spike in multi-family homes as single-family starts fell 4.2 percent to a new 15-month low.
- Japan's economy grew a meager 0.4 percent in the second quarter and highlights the struggle among developed economies to reignite growth.
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 bond rally that began in April may be at risk of running out of steam as the magnitude of the move has been dramatic. Anecdotally the bullishness in bonds may be nearing an extreme.
