The Economy and Bond Market (May 21, 2012)
Treasuries rallied this week, sending long-term yields sharply lower. With headlines touting bank runs in Greece and Spain, the risk-off trade was in full swing this week as both gold and the U.S. dollar rallied along with Treasuries. Ten-year Treasury yields hit the lowest level in 60 years this week and German 10-year bonds hit new record lows as part of the risk-off/fear trade.
Strengths
- The consumer price index for April was unchanged and the trend in inflation data is lower.
- Housing starts rose 2.6 percent in April as the housing market remains a bright spot.
- Central banks remain supportive as the Fed minutes released from the April Federal Open Market Committee (FOMC) meeting hinted at more monetary easing if the economy slows. The Bank of England echoed similar thoughts and the market sees higher chances of additional quantitative easing.
Weaknesses
- The Conference Board Leading Economic Index fell 0.1 percent in April.
- Chinese power production rose a modest 0.7 percent, the smallest gain since May 2009.
- Eurozone industrial production fell 0.3 percent in April; expectations were for a gain of 0.4 percent.
Opportunity
- Bonds continue to grind higher and appear to be forecasting benign inflation and slow growth.
- The Federal Reserve appears willing to increase monetary accommodation if necessary, which would be a boost to the bond market.
Threat
- China’s economy is slowing faster than expected and government policy makers appear comfortable with this dynamic.
- Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.
