The Economy and Bond Market Cheat Sheet (October 11, 2011)
In an interesting twist, bond yields rose for a second week in a row, even though the news flow was negative. The most significant story of the week was the news that Dexia, a French/Belgium bank, would essentially need to be nationalized and other French banks would require additional capital. Moody’s also downgraded Italy’s sovereign debt rating late in the day on Tuesday. The interesting aspect about these events was the market’s reaction as equities rallied and bonds sold off. The market had been anticipating a negative event in the European financial markets, but now the veil has been lifted. Dexia and other French financial institutions were the primary issue that had been weighing on the market and now that this is fully out in the open, the market stopped trading on the fear of the unknown.
The chart below shows two-year Treasury yields at the highest levels in two months, likely driven by a combination of a reduction in the “fear” trade and the Federal Reserve’s recently announced “Operation Twist,” which sells short-term Treasuries and buys long-term Treasuries.
Strengths
- The September employment report was better than expected with nonfarm payrolls growing 103,000 versus an estimate of 60,000.
- The ISM Manufacturing Index unexpectedly rose to 51.6 in September, indicating continued expansion in the manufacturing sector.
- Retail sales were surprisingly strong as overall retail sales grew 5.1 percent year-over-year in September on better than expected back to school demand. Auto sales were also strong in September with GM’s total U.S. sales up 20 percent, Chrysler increasing 20 percent and Ford rising 9 percent.
Weaknesses
- The JP Morgan Global Manufacturing Purchasing Managers Index (PMI) fell into contraction territory in September.
- The eurozone’s service sector contracted for the first time in two years.
- Bank bailouts in Europe three years after the global financial crisis highlight the significant challenges that still face the global economy.
Opportunities
- With the economy weak and concerns brewing about an additional financial crisis, the Fed will remain accommodative for some time and bonds appear well supported in the current environment.
- Globally, central banks have become attune to the risks of a global slowdown and will likely act to bolster economic growth.
Threats
- The threat of a more significant global economic slowdown than many expected just a couple of months ago has increased sharply.
- The threat of another global financial crisis cannot be ruled out.
