Rates Have Dropped This Week!
Slowing Economy – this has been the driving force pushing the Bond market higher in recent weeks. And despite strength in Stocks, some poor auction results and volatility along the way, the Bond market has continued to move steadily higher. But it can’t keep moving higher – or can it?
In order to see how much further prices can improve, we have to take a look at the charts to see where we have been. We also have take a look at how the US Dollar plays a role into this.
Technically – we can’t ignore the charts. Mortgage Bonds and Treasuries are trading right near important resistance. A look at Mortgage Bonds in a 6-month view on the Bond Page, shows the Bond is approaching a ceiling it has not traded above since early December 2010. And the last time prices were at this ceiling, we saw a quick and significant sell off in the Bond. Going forward – if prices can resist being pushed back and convincingly break above this ceiling in the $99.78 area – this tough resistance will now become support – meaning that prices could move higher still and this $99.78 area would help prices from further decline. There are a lot of “if” and “buts” and news can quickly disrupt any technical signals – so it is important for your clients to understand that things could change very quickly.
The US Dollar continues to decline and is currently at $73.18. We looked at charts of the US Dollar and see that it has support in the $71 – $72 area – which represents the lowest value for the Dollar that we can see. With QE2 and the dollar printing presses going full steam through the end of June – we should expect the “greenback” to erode further and test this very important floor of support. How the US Dollar performs after QE2 may have a meaningful effect on the Bond market. A persistent weak US Dollar is ultimately not good for Bonds as a continued decline would make US dollar denominated assets like Treasuries and Mortgage Bonds less attractive. A weak Dollar is also inflationary as it makes our imports more expensive.
And here’s what recent history and Fed action has done to the US Dollar. It is important to note that the US Dollar declined sharply once the Fed announced the extension of QE1 in March of 2009 – at the same time the Stock market started it’s historic rally higher. We also all have seen a sharp decline in the US Dollar in response to QE2 – and this has fueled Stocks further higher. Once the QE2 and the government support of the economy slows – it may actually be good for the US Dollar. But a lot will depend on how the economy performs once the government removes the “crutches” of QE and easy monetary policy. And that is the debate many economists and portfolio managers are having as well as Traders in the Bond pits. If the economy, which has stubbornly high unemployment and millions out of work, doesn’t pick up on it’s own post-QE2 – the Fed will continue it’s accommodative monetary policy as much as it can to avoid inflation – this to support the economy and push Stocks higher still. And this would have a further negative effect on the US Dollar and likely Bonds.
For you longer-term readers – in the wake of QE2 and even for our Forecast for 2011, we didn’t expect rates to shoot dramatically higher, but at the same time – we don’t expect Bond prices to revisit the price of highs of Nov 2010 when QE2 was announced – because in order for rates to get that low again – the economy would have to endure more pain, QE2 would have to have been a failure and we would have to slip into a deflationary environment. What the economic reports show in coming months will help give clarity to how the economy stands as the Fed withdraws QE2. We will say this – we are not encouraged by the uptick in Initial Jobless Claims, which suggests the pain in the labor market will continue to weigh on the economy.
So how did this morning’s reports look:
Today’s economic data, Chicago PMI and Consumer Sentiment were reported pretty much in line with expectations. The Core Personal Consumption Expenditure Index, a reading on consumer inflation rose 0.1% in March, leaving the year-over-year Core rate at a tepid 0.9%. Personal Income and Spending were slightly higher. This tame inflation reading, for now, is also helping to support Bonds.
Bottom line – In talking with clients and referral partners – advise that Bonds are close to a position to break out higher, which would lower rates further still. However – in order for this to happen, the Bond must break above nearby resistance. Longer-term – how the economy performs post QE2 will determine which way Bonds are headed. If the economy slips and the Fed has to remain further accommodative – this could be a Dollar negative – just as prices test their important support at the $71-72 area. A weak Dollar is ultimately not bond friendly.