The Economy and Bond Market Radar (March 10, 2014)
Treasury bond yields moved sharply higher this week as economic data was generally supportive of continued economic recovery as well as maintaining the current quantitative easing (QE) taper pace. Two key pieces of economic data were released this week, the ISM manufacturing index and the employment report. The ISM Manufacturing Index bounced back in February, ahead of expectations. Nonfarm payrolls grew ahead of expectations by 175,000 in February, and considering all the bad weather, the market embraced this number. One other indicator that is not normally highlighted can be seen in the chart below, which shows that household net worth grew by nearly 14 percent in the fourth quarter versus a year ago. That is close to a $3 trillion change in net worth in the fourth quarter, partially explaining some of the enthusiasm for equities and the housing market.
Strengths
- The ISM Manufacturing Index rose to 53.2 in February, back into expansion territory even with poor weather during the month.
- The February employment report was generally well received as nonfarm payrolls grew by 175,000, beating low expectations.
- Household wealth surged by almost $3 trillion in the fourth quarter. The Federal Reserve was aiming to create a wealth effect through QE to spur on the economy, and they appear to have accomplished just that.
Weaknesses
- The ISM Non-Manufacturing Index fell to 51.6, the worst reading in four years, and a counterpoint to the better ISM manufacturing data.
- Auto sales at General Motors and Ford fell in February. The companies cited bad weather, but that still creates a question mark for the economy.
- A debt default by a solar company in China raised concerns this week for the broader financial sector in China, along with the country’s ability to continue growing at the government-set 7.5 percent.
Opportunities
- The Federal Reserve member commentary this week more-or-less confirms that tapering would proceed as planned.
- The International Monetary Fund (IMF) released a report recently highlighting the deflation risk in Europe. It is exactly this type of thinking that could spur additional easing policies from the European Central Bank (ECB), even though that did not happen this week.
- There are many moving parts to the taper decision and although the Fed began the process, it is very possible that tapering could be delayed if the economy stumbles.
Threats
- Several emerging market countries are raising interest rates at an aggressive pace to either deal with inflation or a weak currency. It could be the beginning of a new global interest rate cycle for higher rates.
- Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- China remains a wildcard for economic recovery and the economy has shown some cracks in recent months. This is similar to how last year started and China found its footing, something similar needs to happen this time around.
