The Economy and Bond Market Radar (December 23, 2013)
Treasury bond yields were mixed this week even as the Fed somewhat surprised the market by announcing that tapering would begin in January. The Fed will reduce the amount of quantitative easing by $10 billion per month to $75 billion. The intermediate portion of the yield curve saw the bulk of the adjustment with 5 to 7 year Treasury yields rising by 10 to 14 basis points. In an interesting twist, the long end of the curve rallied, with 30-year treasuries falling by 4 basis points. The Fed has been talking about tapering for six months, so the market has had plenty of time to digest the potential implications.
Strengths
- Industrial production rose 1.1 percent as cold weather in many parts of the country drove utility output higher. This was the strongest reading in a year.
- November housing starts jumped 23 percent to 1.09 million units, well ahead of expectations.
- The consumer price index was unchanged in November and on a year-over-year basis fell slightly to 1.2 percent. With no inflation pressure, the Fed feels comfortable with a slow exit from quantitative easing.
Weaknesses
- Existing home sales fell 4.3 percent in November, the third straight monthly decline. Low inventory and higher mortgage rates were cited as drivers.
- Initial jobless claims jumped to 379,000 for the week of December 14. The four-week moving average is now clearly trending higher.
- The American Institute of Architectâs Billing Index in November fell to 49.8 from 51.6 in October. This is a widely followed index for commercial construction activity.
Opportunities
- Despite recent conflicting commentary, the Fed continues to remain committed to an overall accommodative policy and is unlikely to raise interest rates in 2014.
- Key global central bankers remain in easing mode such as the ECB, Bank of England and the Bank of Japan.
- There are many moving parts to the taper decision and while the Fed began the process this week, it is very possible that tapering could be delayed if economic data slows.
Threats
- 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.
