The Economy and Bond Market Radar (June 16, 2014)

The Economy and Bond Market Radar (June 16, 2014)

Short-term treasury yields rose this week as Bank of England Governor Mark Carney indicated that interest rates might rise sooner than markets currently expect, which caused similar thinking to cross the pond. The three-year Treasury rose 10 basis points this week, and on an intraday basis hit the highest level since September. The long end of the yield curve was relatively flat, causing the yield curve to flatten.  Economic data has generally been good here in the U.S. and optimism continues to build regarding growth for the rest of the year. The National Federation of Independent Business’s (NFIB) Optimism Index, which measures small business sentiment, rose for the third month in a row and hit the highest level since September 2007.

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Strengths

• May retail sales data was the “big” number to watch this week and on the surface disappointed. May retail sales rose 0.3 percent, which was below expectations, but this was driven by the fact that April’s numbers were revised significantly higher, making for  a much higher base to grow from. The key takeaway is retail sales data point to a second quarter rebound that many have been talking about after GDP contracted in the first quarter as weather disrupted activity.
• Another positive sign of economic recovery came in the Job Openings and Labor Turnover Survey (JOLTS)  report, which showed that employers posted 4.5 million job openings in April, the most in seven years.
• Eurozone industrial production rose 0.8 percent in April, twice the consensus estimate which reinforces the European recovery story that is unfolding.

Weaknesses

• As mentioned above, the UK is moving closer to raising interest rates as the central bank is concerned that housing has become overheated and easy policy risks have created another bubble.
• The preliminary reading for the University of Michigan Consumer Sentiment Index came in below expectations and below May’s level.
• Short-term bond yields are heading higher and the market is becoming more anxious regarding the Federal Reserve’s quantitative easing (QE) exit plan.

Opportunities

• Housing starts and building permits for May are scheduled for release next week. This is a crucial time for the housing market. If we don’t see an uptick soon, we probably won’t see one this year. This could actually be a positive for the bond market as a weak housing environment likely keeps the Fed from shifting to a tighter policy.
• The Consumer Price Index (CPI) is also scheduled to be released next week, and with the Producer Price Index (PPI) showing a disinflationary trend this week, CPI should reconfirm for the Fed that easy monetary policy remains appropriate.
• With key global central banks back into easy policy mode and inflation trending lower in many parts of the world, the path of least resistance for bond yields is likely down.

Threats

• The Federal Open Market Committee rate decision and QE adjustment will be announced on Wednesday. Any deviation from the prescribed $10 billion in QE reduction toward a quicker reduction in QE or a more hawkish tone would be a negative.
• Bonds have posted strong returns so far year to date and with economic data looking supportive a modest sell off wouldn’t be surprising.
• While the European Central Bank (ECB) is moving toward easing, UK policy makers at the Bank of England are considering raising interest rates as the housing market has been very strong along with retail sales.