From the July 01, 2011 issue of Futures Magazine • Subscribe!

Treasuries up & economy down


You know the economy must be slowing when even the chairman of the Federal Reserve is admitting it to a room full of the world’s most powerful people in finance. Just parsing Ben Bernanke’s speech to the International Monetary Conference on June 8 reveals a negative outlook for the U.S. economy.

Bernanke said, "U.S. economic growth so far this year looks to have been somewhat slower than expected…A number of indicators also suggest some loss of momentum in the labor market in recent weeks." In Fed-speak, that’s pretty bad.

While 2011 began with a salew of positive numbers that had many analysts hopeful that the tepid recovery was gaining steam, more recent numbers have turned those expectations south in nearly every part of the economy. "At the start of the year, the U.S. economy looked like it had pretty much everything going for it," says Paul Dales, senior U.S. economist at Capital Economics. "Six months into the year, we’re back to the situation where the economy is only growing about 2% a year. We’ve gone from hope that we would see a decent performance, back to general expectations that things are going to be weak for quite a while."

Jim Barrett, senior market strategist at Lind-Waldock, also doesn’t see things picking up in the economy any time soon. "People may be a little overly pessimistic about the economy right now, but it’s hard to see an uptick that really would threaten note and bond prices," he says. Barrett expects yields on the 10-year to stay below 3%, working down to 2.80% and possibly 2.75% if the stock market really gets bad. That’s a trading range of 123-00 to 126-50. He expects the 30-year bond to be a bit more volatile with a trading range of 125-00 to 129-50 through the summer.

Brian Edmonds, senior managing director and head of interest rate trading at Cantor Fitzgerald, expects Treasuries to remain strong despite QE2 ending in June. Edmonds says bonds and notes have rallied this spring because of poor economic numbers and any weakness from the end of QE2 would be offset by the Fed’s pledge to continue reinvesting principal payments from its securities holdings.

Edmonds says there is an outside chance of a QE3 if the economy does not improve, but doesn’t expect that to happen immediately following the end of QE2. "There will be a lag time," he says.

By nearly every measure of the economy, the outlook has turned negative since the beginning of May. This is true in housing, jobs reports, GDP projections and interest rate expectations. Naturally, many of these are related.

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