Economic Update 6-1-09

Friends and Colleagues

Summer is in the air, and with it, a sense of muted optimism…or so we are told.  Scott Anderson of Wells Fargo Economics wonders aloud whether  the recent rise in Treasury rates may be foreshadowing the end of the “recovery”.  Read on to see why we need to keep our eyes on treasuries in the weeks and months ahead. 

 

Recovery?

By certain measures, we have been in a recovery recently.

·      The S&P 500 has gained about 34% since its March low.

·      Initial jobless claims seem to have peaked at the end of March, and have been trending down since then.

·     Consumer confidence has jumped to 54.9 in May from 25.3 in February.

 

Lots of green shoots, and life is all good…right?!

 

But…

Anderson warns us that rising long-term Treasury yields have the potential to wilt the green shoots.

He cautions that rising rates have the potential to cancel out the Fed’s effort to lower the cost of borrowing for consumers and businesses.

He projects that 30-year mortgage rates moving over 5.0% will slow refi and home purchase activity.

This would cause house prices to fall further, and would keep consumer spending at a tepid level.

He worries that if these things occur, it would cause a downgrade for the overall economy.

 

Watch That 10-year Treasury Yield!

Anderson contends that watching the yield on 10-year Treasuries can be a good single indication of the direction of the economy as a whole.

As examples, he cites the following:

·      If the dollar takes a dive because the Chinese are getting nervous about the federal debt or U.S. inflation, it will show up in rising 10-year Treasury rates.

·      If the Federal government decides to change its spending, tax, or borrowing plans, it will cause rising 10-year Treasury rates.

·      As the Fed adjusts or even thinks about adjusting its monetary policy and Treasury purchase programs, the impacts are immediately reflected in the ten-year Treasury yield.

 

Speaking of the Fed Buying Treasuries….

Per Anderson, the recent run-up in Treasury yields is partly due to the belief that the Fed’s commitment to buy $300 billion in Treasuries by this fall will not be enough to stem the flood of new supply as the government tries to borrow its way to prosperity. Resulting speculation says the Fed may soon have to expand its Treasury purchases to keep the recovery alive.

 

And About the Fed Buying MBS….

As an alternate strategy, Anderson suggests the Fed could increase its purchases of mortgage-backed securities (MBS).

·      The Fed has already purchased $427.6 billion of agency MBS.

·      They have current commitments to buy up to $1.25 trillion this year.

·      This has helped lower spreads between the ten-year Treasury and MBS.

·      This keeps banks from having to pass along the full increase in Treasury yields onto the residential mortgage market.

 

Is the Cup Half Empty or Half Full?

Anderson concedes that a rise in long-term bond yields and a steepening yield curve is not always a bad thing.   

It can also signal renewed economic growth and recovery.  

However, this time he contends the cup is half empty, as he believes the recent rise in rates has been more about fears of future inflation and the dollar, federal borrowing and Fed purchase programs.

 

Anderson is an economist….which means he may be right, and he may be wrong.

What do you think?  Will the consumer recovery continue, or are more dark clouds looming on the horizon?

 

As always, our saga continues, so stay tuned…..