The Economy and Bond Market Radar (April 14, 2014)

The Economy and Bond Market Radar (April 14, 2014)

Treasury bonds fell sharply this week as the market received clarity on the Fedā€™s intentions, with the equity market sell-off also providing support. The two-year Treasury yield spiked higher in mid-March, after Fed Chairman Janet Yellen inferred in her inaugural press conference, that interest rates could head higher within six months after the end of quantitative easing (QE), which implied roughly the first quarter of 2015. This timeline was a bit more aggressive than the market had expected and sold off only to completely reverse within the past three weeks. This came as various Fed speakers and Federal Open Market Committee (FOMC) minutes have clarified the Fedā€™s position, which could mean it is in no rush to raise interest rates.

Two-Year Treasury Yields
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Strengths

  • Preliminary same-store sales data for March was better than expected, rising 2.8 percent even with an onslaught of poor weather for a good portion of the month.
  • Initial jobless claims fell to a seven-year low, suggesting that the job market is improving. Job openings also hit a six-year high, showing there are positions to be filled.
  • The NFIB Small Business Optimism Index rose in March as business owners expect the economy to improve.

Weaknesses

  • PPI rose faster than expected in March, jumping 0.5 percent versus the expectation of 0.1 percent.
  • Consumer debt rose by $16.5 billion in February, with student loans being a driver. There has been a lot of negative press recently on the total size of student loans and the potential for another government ā€œbailoutā€ or loan forgiveness.
  • Economic data out of China was disappointing this week and the market continues to look to the government for some form of fiscal stimulus.

Opportunities

  • The Fed has reiterated its intention to not raise interest rates before economic data supports that decision.
  • The International Monetary Fund (IMF) recently released a report highlighting the deflation risk in Europe. This is the type of thinking that could spur additional easing policies from the European Central Bank (ECB).
  • There are many moving parts to the taper decision and while the Fed began the process, it is very possible that tapering could be delayed if the economy stumbles.

Threats

  • In addition to the inherent difficulties in exiting the QE program and the potential for a misstep, there is also the potential for miscommunication from the Fed with the recent change in leadership.
  • Trade and/or currency ā€œwarsā€ cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
  • China remains a wildcard for economic recovery and the economy has shown some cracks in recent months. This is similar to how last year started and China found its footing. Something similar needs to happen this time around.
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