The Economy and Bond Market Radar (June 11, 2012)
After hitting record lows last week, bond yields moved higher this week in what could be best described as a mini “risk on” trade. Economic data remains weak, Europe is still in turmoil and we saw interest rate cuts in China and Australia. It is somewhat counterintuitive that bonds would sell off under such a scenario but this is a similar pattern to other periods when the Federal Reserve enacted quantitative easing. The market has already priced in the easing, and by the time it actually happens, the market is already looking ahead.
Strengths
- China surprised the market by cutting interest rates by 25 basis points on Thursday. It has been speculated the rate cut was a preemptive move, anticipating weak economic data that China is scheduled to release over the weekend.
- Australia cut interest rates by 25 basis points to 3.5 percent, which is the lowest since 2009.
- The ISM Services Non-Manufacturing Index remained solidly in growth territory in May at 53.7.
Weaknesses
- Factory orders fell 0.6 percent in April and have been very weak so far this year.
- The eurozone Purchasing Managers’ Index (PMI) in May fell to the lowest level since June 2009.
- Both the Fed and European Central Bank (ECB) did not offer any additional monetary measures for the market this week, which disappointed the markets.
Opportunity
- Bonds continue to grind higher and appear to be forecasting benign inflation and slow growth.
- The Fed 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 responded this week by cutting interest rates. This likely indicates weak economic data in the near term.
- Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.
