giovedì 27 giugno 2013

How close is the end of US Government bond yields rally?

The trend of the last weeks
US 10 year Government bond yields jumped from 2% on May 22nd – when Fed President Mr. Bernanke suggested that the Fed might cut back on bond purchases some time in “the next few meetings” and the minutes of April 30th/May 1st monetary policy meeting indicated that “a number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting – to 2.61% on Monday 24th. From the lowest level touched on May 2nd at 1.63% yields increased by 98bp.
The upward trend of 10 year yields further strengthened following the Bernanke’s press conference on June 19th, when he confirmed that that the central bank could reduce its purchases this year and halt them around mid-2014. The acceleration of the yields increase fuelled concerns that rising government bond yields could have a negative impact on equity markets. However, S&P500 was so far resilient, falling by a mere 3.4% from the historical high at 1655 set on May 22. On Wednesday 26th 10 year yields corrected to 2.52% as final Q1 GDP data disappointed investors: indeed it was revised down from 2.4% to 1.8% annualized, mainly due to weaker consumer spending growth.
Fed’s reaction
The strong increase of Government bond yields alarmed Fed’s members. For example, Minneapolis Fed President Narayana Kocherlakota said in an interview with CNBC on Wednesday 26th that the bond-market reaction to last week's Federal Reserve decision was "outsized". He also highlighted that the Fed needs to defend its 2% inflation target both from above and below.
Limited upside potential
Our base scenario is that from current level government bond yields have limited upside potential. In our view, 10 year government yields will hardly exceed the 2.75% target for year-end set by Deutsche Bank chief economist Joseph LaVorgna in a recent note. Indeed we believe that the economic outlook does not support a further increase of government yields.
First, because US economy lacks a strong engine of growth in the next few quarters:
1)     Consumer spending is likely to continue expanding at moderate pace (1.5/2.0% annualized) as jobs creation remain weak;
2)     Government spending contribute to economic growth will soften for the spending cut become effective since March 1st; 
3)     Investments are likely to be negatively impacted by the tightening of fiscal policy;
4)     Exports will suffer due to weakening of economic activity in emerging market and recession in the Euro zone.
Second, because inflationary pressures are well contained and are not expected to pick up in the foreseeable future.
The case for being bullish
In our view, the potential for a decline of Government bond yields in the months ahead is higher than the potential for a further increase. In particular should economic activity being weaker than Fed projections for a 2.4/2.5% GDP growth in 2013 and 3.2/3.3% in 2014.
A similar view is shared by Jeffrey Gundlach, head of DoubleLine Capital LP. He said on Tuesday 25th that “the selloff in the bond market is likely to end in the next few weeks and that now is the time to consider buying riskier debt”. Gundlach characterized the selloff in the bond market as a "liquidation cycle" that will end within weeks, once the benchmark 10-year Treasury hits a high of 2.75%.

martedì 18 giugno 2013

USA: CPI and housing market sligthly weaker than expected

May headline consumer price inflation rose by 0.1%, below expectations of a 0.2% increase, and up 1.4% from the prior year. Core CPI, excluding food and energy, rose by 0.2% in line with expectations, and up 1.7% from past year.
These numbers confirmed that inflationary pressures are non-existent now, strenghtening the view that the Fed could continue in its asset purchase programme at current pace.
Housing market data came out slightly worse than market expectations. Housing starts set at 914K, below expectations of 950K, and permits at 974K (exp. 975K).

Germany: Zew index better than expected in June

June Zew economic sentiment index rose from 36.4 to 38.5 beating market consensus at 38.2. It is a sign that German economy could improve at year-end.
With regards to the perspectives of German economy, the focus is now on business confidence indices: PMI manufacturing index due on Thurday 20th and IFO business confidence index due on Monday 24th. The indices should remain almost unchanged compared to the previous month (at 49.9 and 105.7 respectively), in line with a moderate growth rate for the industrial sector in Q3.