The month of May started out on a strong economic footing, with U.S. April non-farm payrolls surprising to the upside, adding 165,000 jobs (more than the 140,000 expected), as well as revising the March number up by 50,000 jobs. The Treasury market began what would be a multi-week selloff (Chart 1) as speculation mounted that the Fed would begin to taper off asset purchases, which are as of now open-ended at $85 billion per month. Meanwhile, Bill Gross, manager of the world’s biggest fixed income fund, tweeted that the 30-year secular bull market in bonds had ended on April 29. It now appears that the optimism was somewhat premature, as economic data this week painted a much gloomier picture of the U.S. economy’s health.
On May 15, the first of the bad headlines hit the wires when the Empire State Manufacturing survey of general business conditions came in negative (-1.43), while expectations were for a positive reading of 4. This was accompanied by a disappointing Producer Price Index, which revealed a larger-than-expected month-on-month contraction in prices (-0.7%), and year-on-year growth barely half of what it was the month before (0.6% vs. 1.1% in March).
On May 16, data on the Consumer Price Index showed a similar contraction in April. Later in the day, upon the release of the surprisingly negative Philadelphia Fed survey (-5.2 vs. expectations for +2.0), the Treasuries rallied further, and Mr. Gross took to Twitter once again to equivocate on his earlier statement, saying, “30-yr bond bull mkt over but bear mkt begins only with consistent 2-3% real and 4-5% nominal GDP growth. Not there yet. Maybe never.”
Federal Reserve officials did little to alleviate the confusion. Federal Reserve Bank of Boston President Eric Rosengren, of the dovish camp and a voting member of the FOMC, defended the current Fed policy to a banking conference in Milan, saying, “Monetary policy has been quite effective in offsetting the contractionary effects of recent fiscal policies,” essentially passing blame for the lackluster success of the Fed’s easy money policies to the government. He also indicated that further monetary easing may be required to spur growth in the economy and keep inflation at the target 2%, dampening speculation of an early end to asset purchases.
Meanwhile, speaking at the same conference, Philadelphia Fed’s Charles Plosser (who does not currently have a vote) poured gasoline on the fire saying that asset purchases should be tapered off starting in June.
We have been steadfast bulls on U.S. Treasuries, even at ultra-low yields. With a great deal of uncertainty surrounding the European fiscal crisis, doubts as to the strength and sustainability of the U.S. recovery, and the likelihood that extremely accommodative Fed policies (not to mention outright asset purchases) will stay in place for the foreseeable future, the safety and liquidity of U.S. Treasuries is hard to beat. Weakness should be viewed as a buying opportunity. Favor the long end of the curve (30 years) where real yields are still positive (Chart 2) over the 10-year notes, which have a negative return after inflation expectations (Chart 3).