The Economy and Bond Market Diary (November 8, 2010)
The Federal Reserve implemented phase two of its quantitative easing program this week, announcing an additional $600 billion of Treasury bond purchases. The surprise to the market is what the Federal Reserve will be buying. The Fed is focusing its purchases primarily in the 2 to 10-year Treasury range and less on the long end of the market. The bond market reacted accordingly with 5 to 10-year Treasuries rallying as yields fell as much as 12 basis points. Meanwhile the 30-year bond sold off, pushing yields up by 14 basis points.
Strengths
- The Federal Reserve followed through on the much anticipated quantitative easing program, more or less meeting investor's expectations.
- The October employment report was much better than expected. The economy created 151,000 jobs and the prior two months were revised higher as well.
- The ISM Manufacturing Index unexpectedly rose to its highest level since May.
Weaknesses
- Retailer's same store sales for October were generally disappointing, rising a modest 1.5 percent.
- The housing crisis continues as Standard & Poor's estimated that the total cost for the bailout of Fannie Mae and Freddie Mac could be $685 billion. Standard & Poor's also reported that large U.S. banks could experience losses of up to $31 billion if forced to buy back mortgage securities.
- Central bankers around the world are taking a different approach than the Federal Reserve as the Bank of England and the European Central Bank both kept monetary policy unchanged. In addition, Australia raised interest rates this week.
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 to drive Fed policy changes going forward.
