The Economy and Bond Market Cheat Sheet (March 21, 2011)
Treasury bond yields fell again this week as safe haven buying continued due to concerns surrounding the unrest in the Middle East and North Africa and the evolving potential nuclear disaster following the Japanese earthquake and tsunami on March 11.
The graph below shows the month-over-month change in the Consumer Price Index (CPI). CPI has been accelerating at a fairly rapid clip over the past few months. Food and energy prices have been the primary drivers which most economists exclude when divining the ātrueā inflation trend. This thought process is fine when prices quickly revert to the mean but that has not been the case in recent years and consumers are feeling the pinch on everyday items. Recent inflation data has not been favorable: For example, producer prices rose sharply as food costs at the wholesale level rose 3.9 percent, the largest increase since 1974. Import prices were also elevated as was Eurozone inflation, which at 2.4 percent was the most since October 2008. This situation bears watching and has the potential to quickly change when the Fed may change direction.
Strengths
- The Conference Boardās Index of Leading Economic Indicators rose for the eighth straight month, indicating continued economic expansion.
- The Philadelphia Fed Manufacturing Index hit a 27-year high in a sign that the manufacturing segment of the economy remains robust.
- At the Fedās regularly scheduled Federal Open Market Committee (FOMC) meeting this week, the Fed acknowledged an improving economy but also reiterated no change in monetary policy.
Weaknesses
- Inflation indicators were higher across the board and raise the stakes on continued loose monetary policy.
- Housing starts fell sharply in February, near record lows set in April 2009. Building permits fell to record lows and home loan demand fell 4 percent last week as the housing market remains very weak.
Opportunities
- In an interesting twist, higher oil prices may actually act as a deflationary force if they materially slow global economic growth.
Threats
- Treasury yields could come under pressure as demand for Treasuries wanes. QE2 will end in June and China is already reducing Treasury holdings and Japan is likely to curb its purchases in order to rebuild the earthquake-damaged areas.
