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Weather Is Not the Only Thing Dampening Consumer Sentiment


Consumer sentiment was weak on Friday, but bond market indicators show that investors have not been bullish on the US economy for quite some time.

The University of Michigan index of consumer sentiment came in below expectations on Friday, reporting that the index fell to 79.9 in March versus an expected rise above 81. Analysts had believed that consumers would overlook weather disruptions and offer a rosier outlook for the future. The weak figure, however, leads to speculation that other things are possibly weighing on consumers' minds.

Another way to gauge consumer sentiment is to consult the US Treasury bond market. Price movements in the bond market generally mirror popular views on interest rates, which gives insight into the performance of the economy over the coming months and years. Current analysis shows that the US bond market could be signaling weak investor sentiment, potentially pulling equity markets lower in coming weeks.

US Yield Curve

The first sentiment indicator is the US yield curve, represented by the ratio of iShares 1-3 Year Treasury Bond (NYSEARCA:SHY) over iShares 20+ Year Treasury Bond (NYSEARCA:TLT). A rising indicator signals that the yield curve is expanding (long-term rates are increasing compared to short-term rates), and investors are predicting a stronger economy in the future. The yield curve has been distorted the past few years as the Federal Reserve's bond-buying program kept long-term rates artificially low. Although the curve hasn't been a great indicator, it is regaining its predictive validity as the Fed continues to wind down its stimulus purchases the rest of the year.

The chart below shows that even though monetary policy started tightening in December 2013, investors are still favoring a contracted yield curve (i.e. lower long term rates). This is due to both investor anxiety about the global economy, as well as fears over US growth potential.

At the beginning of the year, questions began surfacing about the health of the US labor market. The nonfarm employment figure missed expectations from December, all the way through February. Consistent weakness caused investors to question whether tighter monetary policy was the correct move, but the Fed remains steadfast in ending stimulus by the end of the year, barring some unforeseen disaster in financial markets.Economic concerns, alongside geopolitical worries in emerging markets led to a flight into safe haven assets, such as US Treasuries. Conflict between Russia and NATO countries looks to be escalating as Crimea voted in a controversial referendum this weekend to align with Russia instead of the European Union. The yield curve has been uncharacteristically narrow since the 2008 financial crisis due to Fed intervention, but the continued contraction, even as monetary policy tightens, signals that investors are not yet bullish on the US economy.

US Inflation Expectations

The next sentiment indicator is US inflation expectations, represented by the ratio of iShares TIPS Bond (NYSEARCA:TIP) over iShares 7-10 Year Treasury Bond (NYSEARCA:IEF).Treasury Inflation Protected Securities (i.e. TIPS) are bonds issued by the US Treasury that have a coupon linked to the Consumer Price Index, and are thus a preferred investment when investors believe inflation is going to rise. The US economic recovery, since the financial crisis, has been gradual and it has rarely seen consecutive months of growth that were well above estimates. Although fears of a double-dip recession have receded, investors also do not expect robust growth.
The decline of China's economy is another factor weighing on sentiment. Both growth estimates and industrial production in China have repeatedly underperformed forecasts, leading to a fall in commodity prices and fears surrounding emerging market exports. Weakness in the world's two largest economies has led investors to question the legitimacy of rising inflation. Analysts have repeatedly warned that the global trend of ultra-loose monetary policy would spark hyper-inflation, but the demand concerns listed above have increasingly put that argument to rest.

Although the global economy remains stable, uninspiring economic activity together with tighter US monetary policy has led the inflation indicator to steadily decline since last August. The culmination of both declining inflation expectations and a contracted yield curve show that investors are not overwhelmingly bullish, which could keep equity market growth tempered the rest of the year.  

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