The Economy and Bond Market Radar (September 17, 2012)
Treasury yields rose sharply this week as the Fed announced a new round of quantitative easing (QE). The Fed announced an open-ended QE program, purchasing $40 billion in mortgage backed securities each month until the program is no longer needed, and committed to keeping interest rates exceptionally low through mid-2015. It is somewhat counterintuitive for bonds to react negatively to this news, we saw a very similar pattern with prior QE programs; bonds sell off on the announcement as prospects for economic growth increase. This pattern began last week as the European Central Bank decided to implement unlimited EU sovereign bond purchases out to three years. The global easing cycle began a year ago and intensified this week. Even though economic data looks dismal, the market is now able to look past it and toward a recovery.
Strengths
- The Fed exceeded market expectations with an “open ended” QE program and also pledged to keep interest rates exceptionally low through mid-2015.
- The University of Michigan Confidence Index showed surprising strength in September.
- Inflation data remains muted with both Consumer Price Index (CPI) and Producer Price Index (PPI) reported this week, giving the Fed confidence to act.
Weaknesses
- Industrial production was very weak in August, falling 1.2 percent versus expectations for no change.
- Consumer credit unexpectedly fell $3.3 billion in July, the first decline in 11 months.
- Moody’s warned that if lawmakers don’t agree on policies to address the budget deficit next year, the U.S. would be downgraded.
Opportunity
- The Fed and ECB have both enacted new easing policies over the past two weeks and the third leg of the stool is China. China is currently going through a leadership transition that should be finalized by mid-October and that will likely allow the new leadership to take stimulative action.
- 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 with the current leadership shift and lack of recent actions targeted at boosting the economy.
