The Economy and Bond Market Cheat Sheet (April 18, 2011)
Treasury bonds rallied sharply this week sending yields lower across the maturity spectrum. Bonds rallied on a combination of factors including, increased concerns surrounding European sovereign debt risks, modestly weak economic data, better than expected CPI report on Friday and general risk aversion as the stock market fell for the week.
The chart below plots the consumer price index (CPI) and import prices on a year over year basis. The Fed remains focused on stimulating the economy due to continued weak employment growth and very little perceived inflation pressure due to their emphasis on “core” inflation measures. As can be seen below, CPI and import prices track each other fairly well and March data was released for both series this week. On a year over year basis import prices rose 9.7 percent, while CPI rose 2.7 percent but the recent trend seems clear, an uptrend in inflation. Import prices are highly influenced by oil prices which rose 31.3 percent but other areas are rising rapidly as well such as food and beverages, up 18.9 percent year over year and industrial supplies rising 23.5 percent. The dollar index hit a new recent low which means our dollars are buying less from abroad as Canadian import prices have risen 8.2 percent year over year, and goods imported from China have gone up by 2.6 percent year over year which is in line with overall inflation but rose 0.6 percent in March alone. These data points may eventually force the Fed to act and it is widely accepted that if you wait for inflation to show up before taking action it will probably be too late to effectively control it.
Strengths
- Retail sales rose 0.4 percent in March which is a relatively strong showing given high gasoline prices.
- Job openings hit the highest level since September 2008, signaling improving employment conditions.
- March industrial production rose 0.8 percent, beating expectations and continuing the trend of strength in the manufacturing sector.
Weaknesses
- While core measures of inflation remain moderate, the headline figures from the CPI, PPI and import prices are all signaling higher inflation.
- Initial jobless claims rose to 412,000 in a disappointing set back for the jobs picture.
- The IBD/TIPP Economic Optimism Index fell sharply, hitting the lowest levels in 33 months, gasoline prices were apparently a key driver.
Opportunities
- In an interesting twist, higher oil prices may actually act as a deflationary force if it materially slows the global economic growth.
Threats
- Budget cuts and austerity measures in Europe and the U.S. are necessary “evils” but will likely be a considerable drag on global growth.
