The Economy and Bond Market (July 29, 2013)
The treasury market sold off modestly this week as yields moved higher on Fed quantitative easing (QE) tapering uncertainty. There really were two issues in play this week. The first revolves around potential Fed action in reducing the current $85 billion a month QE program, which many believe will be reduced at the September 17-18 FOMC meeting and which makes the bond market nervous. The market will be looking for clues from next weekâs FOMC meeting. The other issue is Fed Chairman Ben Bernankeâs upcoming retirement and his likely replacement. The two frontrunners are current Federal Reserve Vice Chairman Janet Yellen and former Treasury Secretary Larry Summers. The market views Yellen as more dovish and likely to continue the current QE program, while Summers is viewed as more bearish and likely to end QE sooner rather than later. These two issues are what drove mid-week volatility in the treasury market and while we will get some clarity next week, the next Fed Chairman likely will not be determined until this fall.
Strengths
- U.S. consumers reported being more upbeat with the University of Michigan Confidence Index rising in July ahead of expectations. Bloombergâs Consumer Comfort Index also hit its highest reading since January 2008.
- While housing data has been mixed recently, new home sales rose 8.3 percent and mortgage rates fell for the first time in eleven weeks.
- International data was generally better this week. South Koreaâs GDP rose 1.1 percent in the second quarter and ahead of expectations, the U.K.âs economy grew 0.6 percent in the second quarter, and the German Ifo Business Climate Index rose for the third straight month and slightly above forecasts.
Weaknesses
- HSBCâs flash PMI for China unexpectedly fell to an eleventh-month low.
- Gasoline prices rose $0.12 this past week with higher prices expected in the next few weeks.
- Home loan applications hit a two-year low and commentary from homebuilders this week indicated the housing market is already being hurt by rising mortgage rates.
Opportunity
- Despite recent commentary, the Fed continues to remain committed to an accommodative policy.
- Key global central bankers, such as the European Central Bank (ECB), Bank of England and the Bank of Japan, are still in easing mode.
- The recent sell-off in bonds is likely an opportunity as higher yields will act as a brake on the economy and potentially become self-fulfilling, thus postponing Fed tapering.
Threat
- Inflation in some corners of the globe is getting the attention of policy makers and may be an early indicator for the rest of the world.
- Trade and/or currency âwarsâ cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- The recent bond market sell-off may be a âshot across the bowâ as the markets reassess the changing macro dynamics.
