The Economy and Bond Market Radar (September 23, 2013)
Treasury yields rallied sharply this week as the Fed surprised the market by not adjusting its QE program. The Fed had been communicating this tapering message to the market since May. By not following through, the Fed truly surprised just about everyone, possibly hurting its credibility and adding uncertainty, which the market dislikes, potentially leading to more volatility.
Strengths
- The Fed took a data-dependent approach and decided not to taper its QE program, igniting a significant bond rally.
- Industrial production rose 0.4 percent in August as auto production rebounded 5.2 percent.
- Leading indicators rose 0.7 percent in August, with broad-based strength indicated, which bodes well for economic growth over the next few months.
Weaknesses
- India unexpectedly raised interest rates by 25 basis points as inflation remains a problem in some emerging markets.
- The economy has been weaker than the Fed expected, thus not allowing it to taper as expected.
- According to Business Roundtable, large company CEOs are less optimistic about economic prospects over the next six months.
Opportunity
- Despite recent conflicting commentary, the Fed continues to remain committed to an overall accommodative policy and is unlikely to raise interest rates in 2013 or 2014.
- Key global central bankers remain in easing mode, such as the European Central Bank, Bank of England and the Bank of Japan.
- The bond market rally over the past two weeks has been impressive and may still have some running room.
Threat
- Inflation in some corners of the globe is getting the attention of policymakers and may be an early indicator for the rest of the world.
- Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- The recent bond market selloff may be a “shot across the bow” as the markets reassess the changing macro dynamics.
