Must-know: Why the Treasury yield curve declined last week

Must-know: Why the Treasury yield curve declined last week (Part 1 of 7)

Why the S&P 500 scaled new heights in the 1st quarter of 2014

Economic indicator overview for the week ended May 30

The week ended May 30 received mixed signals from macroeconomic indicator releases.

GDPEnlarge Graph

GDP

The final gross domestic product (or GDP) figures released by the Bureau of Economic Analysis (the BEA), U.S. Department of Commerce, on May 29, 2014, revealed that the first quarter growth in the U.S. economy was weaker than reported earlier. This was mainly attributable to the adverse weather turning growth negative. Real GDP growth for the first quarter was revised down to an annualized -1.0% from the advance estimate of 0.1% and compared to the fourth quarter’s (2013) 2.6%. The decline is the first since a 0.7% dip in the third quarter of 2011.

GDP estimateEnlarge Graph

S&P 500 Index

The markets, however, have largely not paid much heed to the contraction, with other recent economic indicators seeming more encouraging. Adding to the latest positive signals was an uptick in consumer confidence and greater demand for manufactured goods.

The week ended with the S&P 500 Index up 1.2% to 1924 points, clocking a year-to-date total return of roughly 5%. The index notched a string of fresh record highs for the week. The yield of the ten-year U.S. Treasury note was down 6 basis points to 2.48%.

Consumer confidence rose

The Conference Board’s consumer confidence index, released on May 27, rose to 83.0 in May from 82.3 in April. This was the second-highest reading in more than six years. Consumers are now apparently more upbeat about the present economic conditions and about the labor market in particular. More respondents in May agreed that jobs were plentiful, with fewer saying they were hard to get. Consumer spending, however, didn’t see the same uptick.

Durable goods orders

New orders for durable goods manufactured in the U.S., released by the Commerce Department on May 27, was bolstered by defense spending. Orders rose 0.8% in April, the third consecutive monthly increase. Much of the unexpected uptick in April’s figure was due to a 39% increase in defense orders.

Savings rate

According to the May 30 release by the Commerce Department, the savings rate rose to 4.0% in April from 3.6% in March, as income outstripped outlays.

Personal income grew in April by 0.3%, a slightly slower pace than in March. The dividend income component continued to expand, while wage growth softened. Personal spending edged down 0.1% in April in its first monthly decline in a year. That drop, however, came on the heels of a 1.0% increase in March—the biggest monthly jump in more than four years.

Investors’ takeaway

Growth in GDP translates to healthier corporate profits, which in turn represent a spur in demand for products and services. This may lead to a rise in inflation, and consequently an increase in market interest rates. Higher interest rates lead to a decline in bond prices due to the inverse relationship between the two. Such a fall in prices and a jump in yields directly reflect in the performance of popular Treasuries and investment-grade corporate bond market exchange-traded funds (or ETFs) like the iShares Core Total U.S. Bond Market ETF (AGG), the Vanguard Total Bond Market ETF (BND), and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), which tracks the performance of the U.S. investment-grade bonds of companies like Verizon Communications (VZ) and BofA Merrill Lynch (BAC).

The next part of this series discusses how these economic releases have impacted Treasury yields.

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