The Economy and Bond Market Radar (March 24, 2014)
Treasury bond yields moved sharply higher this week, especially in the short- and intermediate-portions of the yield curve. The rate moves were driven by Fed Chair Janet Yellen’s post Federal Open Market Committee (FOMC) meeting comments, which potentially implied that the Fed could raise interest rates as soon as early 2015. This surprised the market, which was expecting a much more “dovish” stance. The short end of the curve responded immediately with yields spiking higher. The Fed moved ahead with another $10 billion in tapering for April, meeting expectations. The very long end of the curve was much less affected, with all the action in the shorter maturities.
Strengths
- Industrial production rose a better-than-expected 0.6 percent in February. Along with higher capacity utilization, this potentially bodes well for hiring and spending activity in the coming months.
- The consumer price index rose 0.1 percent in February and 1.1 percent on a year-over-year basis. Inflation remains very low, giving the Fed plenty of room to maneuver.
- Housing starts for February were in line with forecast and January’s data was revised higher, which was a relatively good showing. The positive surprise came in building permits which rose to more than 1 million annualized units, up nearly 8 percent from January.
Weaknesses
- Fed Chair Yellen threw the market a curve ball this week, adding a level of policy uncertainty that was unexpected, leading to a spike in yields.
- Housing data was not all rosy this week, with existing home sales falling modestly in February.
- The U.S.-imposed sanctions on Russia and numerous Russian businessmen have the potential to weaken global growth prospects if tit-for-tat retaliation takes place.
Opportunities
- The Fed likely will follow a data-dependent path for monetary policy and this week’s testimony likely will be refined in coming weeks.
- The International Monetary Fund 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, especially as the euro continues to strengthen and approaches the 1.40 level versus the dollar.
- There are many moving parts to the taper decision and while 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, but China eventually found its footing; something similar needs to happen this time around.
