The Economy and Bond Market Cheat Sheet (September 26, 2011)
Bond yields fell sharply this week as the Federal Reserve announced the widely expected âOperation Twistâ and recession fears escalated. In Operation Twist, the Fed will sell $400 billion of short-term securities and buy an equal amount of long-term debt in an effort to push down long-term interest rates and, hopefully, spur additional credit demand through lower interest rates. The equity markets were apparently looking for more from the Fed and sold off sharply, implying that the market had anticipated additional quantitative easing (QE3) and was disappointed when that didnât occur. The Fed actions combined with the seemingly never-ending European debt crisis nudged expectations toward a double-dip recession scenario.
Strengths
- The Fed announced Operation Twist in an effort to boost economic growth.
- August existing home sales rose a better-than-expected 7.7 percent.
- The Conference Boardâs Leading Indicators Index (LEI), which we highlighted last week, rose more than expected in August and offers a glimmer of hope in an otherwise difficult week.
Weaknesses
- Greece agreed to more austerity measures in an attempt to secure additional funding from the European Union, International Monetary Fund and European Central Bank troika, but it remains unclear if an agreement can be reached.
- Housing starts fell 5 percent in August. Fannie Mae and Freddie Mae recently announced a fee increase to lenders, which is very likely to filter down to the ultimate cost of a mortgage.
- HSBCâs China Manufacturing Index remained below breakeven for the third month in a row, indicating slight contraction in Chinese manufacturing activity.
Opportunities
- With the economy weak and concerns brewing about an additional financial crisis, the Fed will remain accommodative for some time and bonds appear well supported in the current environment.
Threats
- The IMF stated that the U.S. and Europe could face recession due to political gridlock on both continents.
