"QE3" Odds Improve on Weak August Employment and ISM

The Economy and Bond Market Radar (September 10, 2012)

Treasury yields rose this week, largely in anticipation that the employment report released on Friday would be good news. The employment report showed non-farm payrolls growing a meager 96,000 and payrolls for the prior two months were revised down by 41,000. This was a poor report and well below analysts estimates, which improves the odds that the Fed takes action next week with another round of quantitative easing but Treasuries couldn’t recoup the loses suffered earlier in the week. Another factor at work was the ECB’s decision to implement unlimited European Union sovereign bond purchases out to three years. This action follows more than a month of building expectations and the ECB was able to follow through on its commitment to save the euro. This policy will give European governments more time to fix their fiscal situation.

Strengths

• The ECB announced a sovereign bond purchase program this week which continues to solidify the reputation of the ECB as finally truly doing what it takes to adequately address the current crisis.
• U.S. auto sales rose by nearly 20 percent from a year ago with broad-based gains among most of the global auto makers. Auto production in Brazil rose 10.6 percent in August vs. July and sales rose 15.3 percent to a record 400,000 units, driven by tax cuts and lower borrowing costs.
• The ISM Non-Manufacturing Index rose and beat expectations for August, indicating expansion.

Weaknesses

• The August employment report was weak and it is difficult to identify a near-term catalyst that will change that situation.
• The August ISM Manufacturing Index remained in contraction territory for the third straight month.
• Eurozone retail sales fell 1.7 percent in July and economic data coming out of Europe has been very weak.

Opportunity

• The ECB acted this week to address liquidity and confidence issues in the marketplace and the Fed appears likely to act next week on an additional round of quantitative easing.
• With further weak economic data out of China, odds of additional easing measures continue to move higher.
• Interest rates are likely to remain very low for the foreseeable future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.