What a week it’s been. Just look at the ups and downs of the yield on the benchmark 10-year Treasury note.
The week started with the safe haven play related to the Irish fiscal and financial crisis, which pushed the yield on the 10-year bond below 3 percent. In a spillover from last week, global investors increasingly turned to U.S. government bonds for refuge from the Irish fiscal and financial woes. Over the next few days, the Irish government and its EU partners (including the ECB) struggled to get ahead of the markets with a new fiscal stabilization and recovery program. However, uncertainties over policies going forward remained, and the EU crisis escalated. Spreads widened between the sovereign bonds of Germany (still considered the most solid sovereign) and other EU countries considered potentially vulnerable to increased market attack because of their fiscal imbalances. As we‘ve seen often during the past few crisis years, investors turn to US government bonds when a fiscal, financial, or economic crisis picks up elsewhere.
As the week progressed, yields on the 10-year U.S. government bond reversed course and rose over 3 percent when a growth play took over. The drivers in the shift were better news from Europe but also stronger than expected U.S. economic news, including preliminary signs that the consumer may be bouncing back for the important Christmas season (which accounts for the bulk of total annual retail sales). So many market participants reassessed their economic outlook and revised their growth forecast slightly upward. Market chatter even picked up about the economy needing less support from the Fed through quantitative easing and some commented that the Fed might tighten sooner than anticipated (although still not right away).
And then November’s unemployment data was released today. While the data contained some upward revisions for earlier months’ estimates, the main message taken from the surprising uptick in the unemployment rate from 9.6 to 9.8 percent was that the economy is still continuing to struggle and the recovery remains subpar. So yesterday’s optimism gave way to more caution: the yield on the 10-year bond reversed course again to go below 3 percent.
Looking ahead, critical backdrops to market developments remain Fed activities and the lame duck session votes on fiscal policy in Congress now under way. Market focus is on whether fiscal policy will be tightened or not on January 1st and, whatever Congress decides, will it be across the board? Markets are also paying close attention to the Fiscal Commission’s report for fundamental changes going forward, as Congress heads into the next budget cycle in 2011.