Why the decrease in China’s PMI means higher demand for Treasuries

Part 4
Why the decrease in China’s PMI means higher demand for Treasuries (Part 4 of 6)

Changes in China’s PMI affect Treasury rates and stocks like Revlon

The effects of China’s falling PMI

In 2014, China’s Purchasing Managers’ Index (or PMI) readings for both January and February came in below 50, signifying that the Chinese manufacturing sector had contracted. The PMI for China recorded its fourth straight month of decline in February 2014. The index recorded a value of 48.5 in February, down one point from January’s reading of 49.5.

Part 4Enlarge Graph

China’s February PMI report was issued on March 3. Global financial markets took the news of a slowdown in China quite hard. On the same day, market yields on U.S. Treasury securities at 30-year and 10-year constant maturities declined by 6 basis points (or bps) and 4 bps, respectively.

“I would not expect China to be the big boom that we’ve been used to,” said Doug Oberhelman, Chairman and CEO of Caterpillar (CAT), the world’s largest construction and mining equipment manufacturer at a construction equipment show recently. Coca Cola (KO) reported slower sales growth in China last quarter, holding emerging markets partially responsible for the 8% decline in net income in Q4 2013. Last December, cosmetics company Revlon (REV) announced that it was exiting China.

Historical correlations

Correlations (a statistical measure used to assess whether the variables under consideration move together) between percentage changes in monthly readings of the manufacturing PMI and percentage changes in monthly Treasury yields are presented in the graph above. Correlations between changes in PMI and 10-year and 30-year Treasury securities came in at 0.13 and 0.12, respectively. This implies that, historically, there has been very slight or negligible positive correlation between the two yields and movements in the PMI.

We can attribute the slight correlation to the multiplicity of factors that could cause changes in Treasury yields. Changes in Chinese PMI appear to have a slight influence, historically. However, the drop in China’s PMI will have major near-term implications for U.S. fixed income markets and impact ETFs like TLT and TLH. Read on to Part 5 of this series to learn more.

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