The Economy and Bond Market Radar (December 12, 2011)
Long-term treasury yields ended the week modestly higher as European leaders came together on Friday to form a fiscal pact that placated the market for the time being and led to a sell off in the long end of the Treasury curve.
While there was considerable anticipation and discussion regarding the outcome of the European Central Bank (ECB) meeting on Thursday and Friday’s European Union (EU) summit, the most important piece of data may have come from the other side of the world. The chart below depicts year-over-year inflation in China, which fell to the lowest levels in 14 months. The reason this may be so significant is that this could be a precursor to full-fledged easing in China, which has been the incremental global growth driver in recent years. If China were to cut interest rates, that would be a strong signal that global reflationary policies are back in force and boosts prospects for both global economic growth as well as appreciation in risky assets.
Strengths
- The EU leaders came to an agreement, in principle, on a fiscal pact that will hopefully lead to real reform and stabilize markets in the near future.
- China’s November CPI fell to 4.2 percent and opens the door to more aggressive easing policies in China.
- The University of Michigan Confidence Index rose more than expected in the preliminary December release.
Weaknesses
- Weakness is several Chinese indicators also increases the probability of an interest rate cut as China’s export growth and service sector PMI slowed.
- S&P put negative outlooks on 15 of 17 eurozone countries and the EU may lose its AAA rating as well.
- Factory orders in the U.S. fell 0.4 percent in October and September’s data was also revised lower.
Opportunities
- The Federal Open Market Committee meets next Tuesday and, while expectations are low for a significant change in policy, the Fed could surprise the market.
Threats
- The situation in Europe remains extremely fluid and negative news is almost expected at this point; unfortunately, it is politically driven and difficult to predict outcomes and ramifications.
