Disappointing economic data, bank downgrades, and a continuation of existing policy from the Fed dampened last week’s optimism. Independent audits of the Spanish banking system reported the total bailout required may be less than expected, but were met with heavy skepticism. U.S. housing prices showed solid gains from a year ago, but volume disappointed. Citing slowing employment gains, the Fed expanded its original $400 billion “Operation Twist,” which was set to expire at the end of June. It will sell an additional $267 billion of shorter-term debt to buy longer-term bonds over the remainder of 2012. Some market participants were hoping for more aggressive outright bond purchases, also known as “quantitative easing.” Despite the extension, longer-dated treasury yields rose modestly for the week. U.S. stocks dropped less than a percent and foreign stocks again fell at a faster pace. Gold, oil, and most other commodities declined.
S&P 500: 1,335 (-0.5%)
MSCI EAFE: (-2.0%)
U.S. 10-Year Treasury Yield: 1.67% (+0.09%)
Gold: $1,571 (-3.3%)
USD/EUR: $1.256 (-0.7%)
- Monday – Greece’s newly elected government coalition began working on a proposal to extend the deadline to meet fiscal targets imposed by the bailout.
- Tuesday – Egypt’s Islamist and liberal forces both rallied to protest moves by the military to increase its control.
- Wednesday – The Fed provided a more cautious view of the economy. It extended “Operation Twist,” but did not take additional steps to stimulate the economy.
- Wednesday – Conservative leader Antonis Samara was sworn in as Greek Premier.
- Thursday – The IMF said it opposed the eurozone’s insistence that aid for Spanish banks be channeled through the Spanish government.
- Thursday – More Americans than forecast filed for unemployment benefits, and manufacturing in the Philadelphia region shrank. Stocks fell.
- Thursday – As expected, Moody’s downgraded 15 major global banks.
- Friday – The ECB relaxed rules on acceptable collateral for funding, sparking criticism from representatives of the German central bank.
The global economy is still growing, but it is undeniably slowing. The U.S. remained immune for a time, but no longer is. We remain cautiously optimistic on the U.S. economy, especially if the housing market builds on recent momentum, but it now appears expansion will most likely slow from already low levels before moving higher.
The Fed responded with an extension of “Operation Twist.”
In our view, pushing down long rates makes sense, but only to a point. As treasury rates drop, so do corporate borrowing rates and mortgage rates. This supports economic activity and housing prices. Unfortunately, it requires consistent purchases from the Fed which are hard to sustain, long-term. There are likely to be unpredicted consequences.
Perhaps the primary beneficiary, at the moment, is the U.S. federal government. It has access to unprecedented amounts of extremely cheap money. Because the Fed typically returns interest payments to the treasury, not only is most government long-term debt cheap, a big chunk is essentially free. This sounds great, but the problem is our legislators are notoriously good at spending more money, and notoriously bad at cutting when the flow dries up. It is hard to watch Europe and not worry we will face our own debt crisis sometime in the next decade, particularly if the dollar loses its safe-haven appeal. Compared to Europe, the ability to print money makes all the difference in the short term, but if we ever hope to return to strong growth it will do little to prevent inflation, a collapse in the bond market, or both.
Some of the biggest losers are baby boomers. Many Americans entering retirement are getting very low income from bond holdings and are taking more risk than they realize to do so. More than ever, it is important for retirees to own a portfolio that generates the necessary income through the right combination of capital gains, dividends, and interest.
Having said all this, it is worth noting many in the financial community believe the Fed didn’t do enough. Thursday’s sharp decline in equities and, especially, gold indicates there were expectations for bolder asset purchases.
Image via SXC.hu.