Treasury Closing Summary (January 30)
The economy and the FOMC competed for headlines Wednesday. And it was the weakness in the former which won out. Headlines of a 0.1% decline in Q4 growth faked out the markets and overshadowed a plain vanilla Fed policy statement later in the afternoon. Any underlying fears that the Fed might nuance its announcement toward something a little less dovish (resulting from the split views evident in the December FOMC minutes) were sacked by the morning's report. The response in stock and bond markets was muted, however -- apparent one-offs were largely responsible for the drop in GDP helped contain the downside in stocks, as did beliefs the Fed won't start pulling back on accommodation anytime soon. That limited any run back to Treasuries, while recent bearish momentum and more supply kept yields mostly edging higher.
The big surprise of the day was the shockingly weak, 0.1% decline in Q4 GDP growth following the stronger than expected 3.1% surge in Q3. Expectations had been for a slowing to about a 1.0% pace to end the year. But while the contraction was jaw-dropping, the effect on Wall Street was contained. Two factors accounted for a 2.6% subtraction in growth. First was the 6.6% plunge in government spending (with defense down 22.2%, the largest decilne since the end of the Vietnam War in 1972). That knocked off 1.3% from growth. A $40 bln slowdown in inventory accumulation to $20.0 bln also cut growth by 1.3%. On the bullish side, the private sector continued to do pretty well (relatively). Real spending actually accelerated (aided by a softening in price pressures) to a 2.2% clip from 1.6% in Q3. Fixed investment rose 9.7%, 9 times better than Q3's 0.9%, with equipment and software up 12.4%.
Yet, Wall Street didn't fully discount the data, especially with the Dow at its highest level since 2007 and strocks traded slightly underwater through the afternoon and after the as expected FOMC statement. The drop in Q4 GDP will now heighten talk of a recession given the potential for a Q1 spending slump in the face of 2013 tax hikes and $1 tln in sequestration cuts on the immediate horizon.
The aforementioned FOMC statement was uneventful. As expected, FOMC left rates steady and said it will continue purchasing $85 bln per month. The Fed said economic activity "paused in recent months", but attributed it to "transitory" factors and weather. Employment expanded, household and business investment advanced, while global financial strains have eased. But the Fed still sees downside risks with the unemployment rate remaining elevated. As we suspected KC's George, in her first round as a voter, dissented as she was concerned that the continued high level of accommodation increased future economic and financial imbalances and could eventually push up long-term inflation expectations.
The major differences between the January and December statements were in the first two paragraphs. As noted above the January statement indicated activity "paused," versus last month's economic activity and employment were expanding at a "moderate pace." Like December, some of the slowing was attributed to "weather-related disruptions," but this month "other transitory factors" were added. The Fed said flat out household and business spending "advanced," versus the prior houshold spending continued to advance, but business fixed investment had "slowed." In the policy-related second paragraph the Fed reversed the tone to more accentuate the positive, saying "with appropriate policy accommodation," economic growth will proceed at a moderate pace and the unemplooyment rate will gradually decline. That compares to December's "without sufficient policy accommodation," growth might not be strong enough to generate sustained improvement in the labor market. The Fed's outlook on global financial conditions improved too this month as it noted global financial strains have "eased somewhat" but the Committee still sees downside risks to the outlook. In December the Fed said global financial strains were posed "significant downside risks."
The dollar was pummeled by the report though. EUR-USD touched 14-month highs of 1.3577, but ran into sellers said to be lined up to 1.3600. That figure pretty held through the European close and into the U.S. afternoon. Spec names were reportedly active buyers on the way up.
The day's data started out with promise. The ADP private payroll survey posted a better than expected 192k increase for January, though with a downward revision for December to 185k from 215k previously. This month's increase included a 15k increase for goods employment led by a 15k rise for construction jobs, alongside a 3k drop for factory jobs and a 177k service employment increase. The "as reported" ADP figures ran 17k/month weaker than private payrolls over the three months since the methodology change by Moody's, so the January pop may simply be reversing this undershoot.
Also, the MBA reported its mortgage applications index sank 8.1%, while the purchase index fell 1.8% and the refinance index dove 10.2%, for the week ended January 25. Mortgage rates jerked a bit higher thanks to calm breaking out in Europe and Bund weakness, as the average 30-year fixed rate rebounded 5 basis points to 3.67%, ending a 3-week streak of positive results to start the year off in the mortgage sector. This implies some sensitivity especially in the refi sector to the bounce in rates, even as the NY Fed continues to buy intermediate-longer dated Treasuries and MBS in an attempt to keep a lid on rates and the housing sector alive.
The Treasury's 7-year auction was on the disappointing side and not as good as the prior two offerings this week. The note stopped at 1.416%, tailing only marginally from the 1.408% at the bid deadline. There were nearly $75.5 bln in bids for a 2.60 cover, slightly below December's 2.72, but a little below the 2.78 average. Indirect bidders were awarded 38.2%, only a little below the 39.9% from last month. Direct bidders took 19.7%, just below the 23.1% previously. Primary dealers picked up 42.0%, versus 37.0%.
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