The Economy and Bond Market Diary (October 25, 2010)
Treasury bond yields were little changed this week as the market focus shifted to corporate earnings releases instead of economic data. Expectations continue to build for the Fed Reserve to announce some form of quantitative easing (QE) on November 3 and two Fed officials commented on the likely path the Fed would take. Both speakers indicated a QE program of roughly $100 billion per month or, possibly, the amount could be decided at each Federal Open Market Committee (FOMC) meeting, which occur roughly every six weeks. This incremental approach has pros and cons but may disappoint market participants who favor a “shock and awe” approach of a large upfront commitment of $500 billion to $1 trillion.
Strengths
- Fed officials reiterated views that additional quantitative easing was likely and an announcement could come as soon as November 3.
- China’s economy grew 9.6 percent in the third quarter and continues to be a bright spot for world economic growth.
- Housing starts hit the highest level in five months in a sign of possible housing market stability.
Weaknesses
- U.S. economic data was mixed this week with industrial production declining for the first time since June 2009.
- China raised interest rates for the first time since 2007, largely in an attempt to offset some of the loose monetary policy that is being imported into the country.
- Brazil and Thailand increased taxes on fixed income securities for foreign investors to dampen inflows into the country as the so-called “currency war” heats up.
Opportunities
- Inflation is unlikely to be a problem for some time and this gives central bankers and other policy makers around the world room for expansive policies.
Threats
- Inflation expectations as measured by Treasury Inflation-Protected Securities (TIPS) spreads have risen sharply this month. Inflation expectations will be key data points driving Fed policy changes going forward.
