The Economy and Bond Market Radar (July 22, 2013)

The Economy and Bond Market Radar (July 22, 2013)

The treasury market rallied again this week after Fed chairman Ben Bernanke appeared to back away from a predetermined path for QE tapering during a congressional testimony. On balance, recent economic data has not been very supportive of reducing monetary stimulus. The chart below is an excellent example; housing starts have declined significantly over the past few months as interest rates have risen sharply, apparently crimping demand in this critical area of the economy.

click to enlarge

Strengths

• Fed chairman Ben Bernanke eased market fears somewhat this week, indicating that any policy change will be data dependent and not predetermined.
• The National Association of Homebuilders sentiment index rose to the highest level in more than seven years. This is in stark contrast to the housing starts data.
• Industrial production rose 0.3 percent in line with expectations, but showed strength in autos, which is another critical area of the economy.

Weaknesses

• Housing starts fell again in June. This has been a serious area of support for the economy and one of the key differences between this year and recent years. This weakness is helping to solidify the idea that tapering may be postponed.
• Retail sales in June rose 0.4 percent, but that was well below expectations and feeds into the “economy is not strengthening” narrative.
• June’s consumer price index (CPI) rose by 0.5 percent, and on a year-over-year basis is up 1.8 percent. While it’s not at the level that would evoke a response from the Fed, we have seen some inflation pressures pick up.

Opportunity

• Despite recent commentary, the Fed continues to remain committed to an accommodative policy.
• Key global central bankers, such the European Central Bank (ECB), Bank of England and the Bank of Japan, are still in easing mode.
• The recent sell-off in bonds is likely 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.