By Maulik Mody – Bondsquawk.com
April 11, 2011
The hawkish outlook of economists is evident in the 10-Yr breakeven rate, which reached a 3-year high of 2.66% at the end of last week and currently trades at 2.65%. The 5-Yr breakeven reached a high of 2.46%, its highest in 3 years. Treasury breakeven rate is the difference between the yield of Treasuries and TIPS (inflation indexed securities) having similar maturities which shows traders’ expectations of inflation over years to come. The yield of TIPS is said to be real interest rate, as opposed to the return from Treasuries which is nominal rate. The rally in the past ten days in the 10-yr breakeven rate is shown below.
Wide breakevens are a result of increasing oil prices given the unrest in the Middle East. Crude oil crossed $113 at the end of last week before falling slightly to $111.86 this morning. As a result, consumer prices in the US are expected to gain at a faster pace this week. CPI is expected to have gained 0.5% during March, and 0.2% excluding energy and food prices. The retail price index has advanced at a rate of at least 0.4% since December 2010, setting the stage for inflation.
A closer look at the Treasury and TIPS yields over the past ten days shows that inflation expectations widened mainly as Treasuries declined, pushing nominal yields higher. TIPS have been strong the past week but wider breakevens was a result of both, decrease in real rates and increase in nominal rates. Charts for the yield of 10-Yr Treasury and 10-Yr TIPS is attached below, which explains the rise in breakevens.
Given that the economy is hardly out of the woods, the recovery is yet to gain momentum and stocks are exhausted from resistance from the Japan and Middle-East crisis, breakevens are at relatively higher levels. But this gain will be sustained as traders and portfolio managers will are unlikely to sell TIPS unless concerns about the Libyan crisis ease and energy reverses its gains.
April 1, 2011
The March employment report came in above expectations with a 216k increase in nonfarm payrolls after a 194k increase in February. While weather effects that had boosted February faded with construction shedding 1k workers after rebounding 37k in February, other sectors more than made up the difference. Somewhat surprisingly the manufacturing sector saw a loss of momentum adding just 17k people after 32k a month earlier. Meanwhile the private service sector saw hiring surge to 199k from 167k. Sectors of strength included health care (+45k), restaurants and hotels (+35k), temporary workers (+29k) and retail (+18k). Tax season led to the hiring of 20k accountants after losing 5k in February.
The government sector continued to weigh on overall growth shedding 14k workers after a downward-revised 46k loss. The household survey was stronger than the establishment survey for the fourth month in a row showing a 291k gain and leading the unemployment rate to fall to 8.828% from 8.922%. The participation rate was unchanged making March the second month that the unemployment rate declined mainly on job growth rather than a reduction in the labor force. While it is moving in the right direction, the elevated unemployment rate continues to keep wage growth at bay and average hourly earnings were flat leaving the annual growth at 1.7%, roughly where it has been tracking over the prior year.
Aggregate hours worked rose 0.2% and are rising 2.0% at a 3-month annualized pace, about the same as in Q4. The combination of stable growth in hours worked and wages suggests that nominal growth in take home pay remains stable at just below 4% in Q1. Meanwhile headline inflation has accelerated from 2.6% q/q in Q4 to 5.2% in Q1, likely the cause of the recent slowing in real consumer spending growth. Overall the March report provides further evidence of a broad-based hiring dynamic that is capable of generating self-sustaining growth. However there is still considerable slack that is restraining wage growth pointing to a growing conflict between firms and consumers in absorbing rising commodity prices.
In other releases, the ISM manufacturing index remained strong in March, edging down to 61.2 from 61.4. The details were mixed as production picked up to 69.0 from 66.3 and supplier deliveries increased to 63.1 from 59.4 while new orders dropped back to 63.3 from 68.0 and employment moderated to 63.0 from 64.5 (consistent with the moderation in manufacturing hiring in the employment report). Fifteen of eighteen industries in the survey reported growth and the anecdotes continued to be strong with respondents saying “new orders continue at a robust pace” and that there has been some acceleration in orders in anticipation of higher prices in coming months.
Stocks climbed higher on better employment reports and sustained manufacturing activity. The S&P gained 0.8% at 1336 and NASDAQ climbed 0.6% higher to 2798. Treasuries gained slightly as yields inched lower across the curve. The benchmark 10-yr was trading a basis point lower at 3.46%. Oil price gained as WTI crude traded almost 1$ higher at 107.69. The dollar lost ground against other currencies as the DXY index fell 0.7% to 75.801.
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