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Why Treasuries were strong while investment-grade bonds were muted

Why Treasuries were strong while investment-grade bonds were muted (Part 1 of 9)

Gross domestic product and price inflation impact Treasuries

Quarter-over-quarter GDP growth rises but misses analysts’ consensus

Last week was very important for bond investors and other market traders who keep a close eye on economic indicators and indices, such as gross domestic product (or GDP), the country’s most comprehensive economic scorecard, and the consumer price index (or CPI), which measures the overall rate of change in the prices of consumer goods and services. When GDP expands more rapidly, bond prices (BND) fall. Healthy GDP growth usually translates into strong corporate earnings, which bode well for the stock market (SPY).

Real GDP GrowthEnlarge Graph

Last week, the Bureau of Economic Analysis released its quarterly update on U.S. GDP, which indicated a decline in the fourth quarter 2013 GDP at 2.6%—below third quarter growth of 4.1% and against expectations of 2.7%. The year-on-year GDP growth for 2013 declined to 1.5% from 2.8% in 2012. Declines in GDP are a sign of a declining economy. However, the fourth quarter 2013 GDP was partially impacted by harsh weather.

Plus, the FOMC’s two-day meeting on March 18–19, 2014, revised GDP projections to 3.0% for 2014 and 3.2% for 2015 from early projections of 3.2% (2014) and 3.4% (2015). The Fed’s decision to continue reducing its bond buying by $10 billion a month is evidence of improvement in the economy.

In line with the expected rise in GDP, personal income advanced 0.3% for February 2014, with a 0.2% rise in the wages and salaries component compared to a 0.3% increase the month before. Consumer spending, another important metric to assess tailwinds in consumption, grew moderately at 0.3% in February after rising 0.2% the month before. Core inflation, at 1.1%, remained nearly nonexistent.

Improved labor market

Jobless claims continue to come down, signaling improvement in the labor market. Initial claims fell 10,000 in the week of March 22 to 311,000, which is 12,000 below analysts’ expectations.

The overall manufacturing and housing sector made a positive comeback, with increases in new orders and business activity across the U.S. Both manufacturing and services PMIs registered 55.5% growth for March 2014. Any number over 50% signals that the manufacturing and service economy is expanding instead of contracting. Home prices appreciated across regions, except for the West South Central region. However, home sales by volume remained suppressed, mainly owing to low supply and subdued refinancing activity. Refinancing activity as per a release from the Mortgage Bankers Association fell 8.0% due to a rise in mortgage rates. The weekly purchase index rose 3.0% last week—which may be a trend in the coming months, considering home purchase activities pick up in the summer.

Consumer sentiment for U.S. equity remained strong, as indicated by the State Street Investor Confidence Index. However, the major caveat of the index is that it represents opinion and may differ widely from the actual numbers. Last week, institutional investors remained highly confident about the U.S. equity market at 125.3 levels compared to 113.2 in January 2014. However, fund flows indicated a huge sell-off. Nearly $662.7 million funds were pulled out from the SPDR S&P 500 ETF (SPY) compared to the previous weeks’ inflow of $230.4 million. The fund invests in the 500 largest U.S. firms, including names like Apple (AAPL), Exxon Mobil (XOM), and General Electric (GE), and it’s considered one of the best representations of the domestic economy.

The major bond market ETF, the Vanguard Total Bond Market ETF (BND), reversed the previous two weeks of continuous inflows with $414.2 million of outflows last week. Investors largely favored the U.S. Treasury market (TLT), which continued to post inflows of $29.2 million. Plus, on news that Chinese authorities might come up with more stimulus to boost the economy, last week, emerging market (EEM) ETFs performed slightly better, with nearly $116.2 million of inflows.

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