<

Why demand is rising for Treasuries and investment-grade bonds

Why demand is rising for Treasuries and investment-grade bonds (Part 1 of 5)

Did emerging market tensions pull down US Treasury rates?

Economic growth comes back to the debate

Why should investors worry about their investments when U.S. government officials give an impression of optimism about economic growth with the onset of tapering? Since the numbers aren’t as constructive as the officials are.

A range of U.S. economic indicators mobbed the market last week, mostly indicating sliding economic growth. The evidence also included the release of the gross domestic product by the Bureau of Economic Analysis, which posted a sharp fall to an annualized 2.4% from the advance estimate of 3.2%, compared to the third quarter’s 4.1%. Much of the decline has been driven by harsh weather.

Plus, concerns soared as the retail sales index from the International Council of Shopping Centers plummeted over 0.6% versus the prior period. On the same day, February 25, 2014, Redbook’s same-store year-on-year rate declined to 2.9%, decoding bearish consumer spending.

Feelings were mostly mixed on the housing and labor market fronts. The Mortgage Bankers Association’s activity eased off 8.5%, despite a 1.2% home price appreciation on a seasonally adjusted basis as per the Federal Housing Finance Agency Index. New constructed houses with prior commitment of sale surged 9.6%, above the Street estimates, while initial jobless claims rose 14,000 to a seasonally adjusted 348,000 last week from the previous week’s downwardly revised figure of 334,000.

US Treasury ratesEnlarge Graph

A sentiment-driven market

Despite the run of poor economic data, two things didn’t change. One is Janet Yellen’s stand on the tapering of asset purchases, and the second is investor’s sentiments. The Fed’s current Chair, Janet Yellen, spoke on Thursday, February 27, 2014, confirming that the taper is still on track as a measured step of reducing in the asset purchases. It’s expected to conclude this fall. However, Yellen also mentioned that the Fed will weigh the impact of adverse weather in the labor market and the economy’s overall progress to redesign the pace of the tapering if need be.

Surprises to Wall Street analysts

Of the companies in the S&P 500 that have reported earnings so far, more than 69% have beaten Street estimates, according to earnings. Last week’s release surprises were from Gap, Inc. (GPS), Sempra Energy (SRE), Best Buy Co., Inc. (BBY), and Pall Corp. (PLL), which exceeded earnings per share estimates. Positive earnings also triggered SPDR S&P 500 ETF Trust (SPY) prices to increase 2% since the beginning of the year and about 100 basis point in the last week. Also helping the market was data showing consumer sentiment, which rose more than expected.

U.S. Treasury rates moved southward

The long end of the Treasury curve slipped across the maturity dates ranging from ten years to 30 years. The decline had been expected to be in line with the downfall in U.S. economic data. Plus, emerging markets continued to pose volatility. In particular, the tension building around Ukraine and Russia could trouble the whole economy due to the interdependence factor. Political instability in Ukraine could have a major impact on Russia’s ability to supply gas to Europe. Russia supplies about 25% of the gas to Europe using pipelines running through Ukraine. Secondly, Ukraine is an important link between Russia and other European countries for the export of corn and wheat. If the country’s strategic economic position doesn’t resolve, the market may see an upswing in corn export prices, which would have an impact beyond Europe. Ukraine also coffers a huge debt of about $13 billion this year, and $16 billion comes due before the end of 2015. The country may need some bailouts to avoid defaults on debt payment. However, there’s no clarity on who would supply that economic assistance to Ukraine, considering that even other European countries are just edging up the recovery path and may not be self-sufficient enough handle outside pressures. In a nutshell, both sluggish domestic growth and highly unpredictable emerging markets have suppressed U.S. Treasury rates last week.

In the next part of this series, we detail the impact on the supply market for U.S. Treasuries and investment-grade bonds.

The Realist Discussions