The Economy and Bond Market Radar (June 24, 2013)
Treasury yields rose very sharply this week as Fed Chairman Ben Bernanke and the Federal Open Market Committee (FOMC) more or less repeated prior commentary regarding “tapering” (reducing QE and the first step on a long road toward tightening monetary policy). The Fed was apparently not swayed by negative market reactions in recent weeks and believes beginning the tapering process in the next few months is the most prudent course of action; unfortunately the market disagreed this week.
Strengths
- The National Association of Homebuilders confidence index hit a seven-year high in June. Existing home sales in May rose 4.2 percent, hitting the highest level in more than three years.
- The Philadelphia Fed regional manufacturing index rose more than expected.
- The consumer price index rose a modest 0.1 percent in May. Year-over-year CPI rose 1.4 percent, allowing the Fed plenty of flexibility regarding policy.
Weaknesses
- The very sharp and abrupt sell off in bonds took many by surprise and damaged the psyche of many fixed income investors worldwide.
- The HSBC Flash Manufacturing PMI for China came in below expectations and indicated contraction in the manufacturing sector.
- European car sales hit a 20-year low as registrations fell 5.9 percent year-over-year.
Opportunity
- The Fed continues to remain committed to an accommodative policy.
- Key global central bankers are still in easing mode such as the European Central Bank (ECB), Bank of England and the Bank of Japan. The Bank of Japan, in particular, is aggressively easing currently and the ECB recently cut interest rates.
- The recent sell off in bonds may be an opportunity as higher yields will act as a brake on the economy and potentially become self fulfilling, thus postponing Fed tapering.
Threat
- Inflation in some corners of the globe is getting the attention of policy makers and may be an early indicator for the rest of the world.
- Trade and/or currency wars cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- The recent bond market sell off may be a “shot across the bow” as the markets reassess the changing macro dynamics.
