Monday, 9 July 2007

As global unemployment falls, so do bond prices

Bond markets started the month of July in the same way they started the month of June: with a sell-off.

Government bonds in the United States, Europe and Japan all fell last week, causing yields to rise as most of the data released over the week showed that global economic growth remains strong. According to Bloomberg, the yield on the US 10-year Treasury rose 17 basis points last week, the yield on the 10-year Bund rose 11 basis points and the yield on the 10-year JGB rose 6.5 basis points.

The Global Manufacturing PMI, produced by JP Morgan with research and supply management organisations, rose to 54.4 in June, its highest level since last September, from 54.1 in May. Similarly, the JP Morgan Global Services Business Activity Index rose to 59.6, a 14-month high, from 58.7 in May.

The latest composite leading indicators (CLIs) compiled by the Organisation for Economic Co-operation and Development (OECD) suggest that moderate economic expansion will continue in the OECD area with improved performance in the May CLI’s six month rate of change in all the major seven economies except Italy.

With global economic growth continuing to be strong, central banks are likely to continue monetary tightening. Last Thursday, the Bank of England raised its official bank rate for the fifth time in a year to 5.75 per cent. On the same day, the European Central Bank left interest rates unchanged but president Jean-Claude Trichet said in a press briefing that day that "monetary policy is still on the accommodative side", implying that more rate hikes are foreseen for the future. The previous week, the Federal Reserve had also left interest rates unchanged but mentioned in a statement that it remained concerned about inflation.

One of the reasons that central banks remain concerned about inflation is that resource utilisation remains at relatively high levels in most economies. The Bank of England's decision to raise rates last week was accompanied by a statement saying that "the margin of spare capacity in businesses appears limited and most indicators of pricing pressure remain elevated". Mr Trichet said in his press briefing that "as capacity utilisation in the euro area economy is high and labour markets continue to improve, constraints are emerging which could lead in particular to stronger than expected wage developments" which "would pose significant upward risks to price stability". Similarly, the Federal Reserve's statement accompanying its monetary policy decision in the previous week mentioned that "the high level of resource utilization has the potential to sustain" inflation pressures.

Labour for one has certainly gotten relatively scarce recently. This can be seen in the unemployment rates released over the past week or so for the United States, the euro zone and Japan.

On Friday, the US Labor Department reported that nonfarm payroll employment increased by 132,000 in June, leaving the unemployment rate near a cycle low at 4.5 percent. At least, though, the unemployment rate in the US has stopped falling, thanks to its recent slowdown. However, with the US economy expected to accelerate from the second quarter onwards, a resumption in the downtrend in the unemployment rate over the next few quarters is a real possibility.

Elsewhere in the world, unemployment is still on a downtrend. The unemployment rate in the euro area fell to 7.0 percent in May, the lowest on record. In Japan, the unemployment rate fell to 3.8 percent in May, the lowest in nine years.

It is not surprising then that inflationary pressure for the global economy as a whole remains high. The JP Morgan global index for manufacturing input prices rose to 67.6 in June, the highest since August 2006, from 66.0 in May, while the input price index for services stayed at a relatively high level of 63.0 in June from 63.2 in May.

Under the circumstances, monetary policy globally is likely to continue to tighten. This in turn should keep bond prices under pressure and bond yields elevated.

No comments:

Post a comment