The Economy and Bond Market (November 15, 2010)
Economic news flow was relatively light after an action-packed week last week. The market continued to digest the implications of quantitative easing (QE2), the mid-term elections and employment data. Bonds sold off this week, sending yields higher by as much as 25 basis points on a combination of QE2 trade unwind and speculation that troubled European lenders will be supported by the rest of the Euro region. The stress and concerns surrounding peripheral European countries can be seen in the chart below, which shows the current Irish 10-year bond price, which currently yields about 8 percent.
Strengths
- Mortgage rates fell to a record low of 4.17 percent.
- Consumer debt continued to decline in the third quarter as necessary deleveraging is taking place.
- The University of Michigan Confidence Index rose modestly in November.
Weaknesses
- Soaring Irish bond yields highlight the remaining risks and concerns surrounding the Euro region.
- China raised its bank reserve ratio as it steps up efforts to slow inflation and to offset some of the spillover from the U.S. QE2 program.
- Wholesale inventories rose 1.5 percent in September, matching the largest increase in two years. This is a potential red flag for manufacturing, as the restocking process is likely completed and this data points to slowing sales.
Opportunities
- Inflation is unlikely to be a problem for some time, giving central bankers and other policy makers around the world room for expansive policies.
Threats
- Inflation expectations as measured by TIPS spreads have risen sharply over the past month. Inflation expectations will be key data points to drive Fed policy changes going forward.
