The Economy and Bond Market Cheat Sheet (April 25, 2011)
Treasury bonds rallied sharply for the second week in a row sending yields lower across the maturity spectrum. The bond market was responding to weaker economic data but also to news that S&P placed the U.S.’s sovereign AAA credit rating on negative watch with a one-in-three potential of a downgrade in two years if the deficit issues are not adequately addressed. The chart below plots the U.S. 5-year credit default swap (CDS) spread (cost for protection against default in basis points) which spiked on the news early in the week but, as can be seen in the graph, is still within the recent range for this series. The bond market is well aware of the issues facing the country and this news is not really shocking. It validates the current debate in Washington over how to take debt-reducing action in the near future.
Strengths
- Leading economic indicators rose 0.4 percent in March, rising more than expected and a sign that continued economic expansion is likely.
- March housing starts rose 7.2 percent and building permits rose 11.2 percent. Housing starts and permits bounced from very low levels but the numbers are still encouraging.
- March home resales rose 3.7 percent and prices rose 2.2 percent in a sign housing activity may be picking up.
Weaknesses
- S&P placed the U.S. on negative credit watch, which shines a spotlight on the urgency of addressing the country’s debt situation.
- Initial jobless claims fell to 403,000 but still remain above the 400,000 level.
- Greek 2-year bond yields rose above 20 percent this week as default appears inevitable.
Opportunities
- In an interesting twist, higher oil prices may actually act as a deflationary force if they materially slow the global economic growth.
Threats
- Budget cuts and austerity measures in Europe and the U.S. are necessary “evils” but will likely be a considerable drag on global growth.
