Treasuries Rally Backed By Global Economic Slowdown

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Includes: SPY, VGLT, VGSH
by: Disruptive Investor

Summary

US Treasuries have rallied in the recent past and the rally will continue over the next 1-2 quarters.

Global economic slowdown at a time when the US economy is showing strong resilience is driving liquidity into Treasuries.

I also remain positive on US equities for the same reason and my view is to buy equities on any weakness in the markets.

The US Treasury bond yield has declined from almost 2.3% at the beginning of December 2014 to current levels of 1.91%. I am of the view that the rally for Treasuries will continue in the foreseeable future and this article discusses some of the key factors that have taken Treasuries higher and that will maintain the positive outlook for Treasuries in the coming quarters.

The single biggest factor that is driving Treasuries higher is US economic strength at a time when the global economy is slowing down. The indication of economic resilience in the US comes from 3Q14 GDP growth, which was robust at 5%.

The indication of economic resilience also comes from the minutes of the FOMC meet. According to the FOMC minutes -

Real personal consumption expenditures (PCE) appeared to be rising robustly in the fourth quarter. The components of the nominal retail sales data used to construct estimates of PCE rose strongly in October and November, and light motor vehicle sales increased noticeably. Key factors that influence household spending pointed toward further solid PCE growth.

Continued improvement in the job market and consumer confidence at its highest level since the financial crisis are the other indicators of the point that the US economy remains resilient and GDP growth is likely to be robust in the coming quarter.

Amidst strong economic growth in the US, the global economic data is getting weaker and this point is backed by a single chart below that gives the global PMI.

With the US economy remaining resilient, any decline in the global PMI would be clearly coming from the rest of the world and it is clear from the chart that the global PMI is on a relatively sharp downturn.

The manufacturing PMI has declined from 51.8 in November 2014 to 51.6 in December 2014. The services PMI has seen a sharper decline from 53.5 in November 2014 to 52.3 in December 2014. Further, the composite PMI has also declined from 53.2 to 52.3 during the same period.

While the indicators are still some distance away from global recession, the recent slump in the global services sector is alarming and if this decline continues, there can potentially be a global recession in the coming 3-6 months.

The implications for different asset classes is as follows -

  • Negative outlook for industrial commodities as China's economic woes continues. In all likelihood, China's 2015 GDP growth will be lower than 2014 GDP growth.
  • Negative outlook for oil as oversupply ensures lower prices and a global economic slowdown ensures weak consumption trend.
  • Negative outlook for China equities as economic weakness ensures that equities will not move higher. I had recently discussed the reasons to be bearish on China equities here.
  • Negative outlook for Euro-zone equities as a potential recession and deflation keeps sentiments bearish for 2015.
  • Negative outlook for gold in the near-term as a strong dollar coupled with US economic resilience implies no immediate money flow into the precious metal.

The reason for outlining the potential direction of various asset classes globally is to underscore the point that there are very few asset classes that are attractive at this point of time. The US Treasuries find favor backed by strong performance of the US economy.

Further, if the Euro-zone slump into recession and deflation, a massive QE is entirely likely in the region and that will be more supportive for US equities as well as US treasuries.

Therefore, at least for the next 1-2 quarter, the Treasuries will continue to rally. The prospect of an increase in interest rates later in 2015 is also contributing to the attractiveness of US Treasuries relative to other bond markets.

Therefore, the Vanguard Long-Term Government Bond ETF (NASDAQ:VGLT) and the Vanguard Short-Term Government Bond ETF (NASDAQ:VGSH) look interesting for the next 1-2 quarters.

Over the long-term, I remain bearish on US Treasuries as the government debt continues to pile on. Treasuries however offer potential for attractive returns in the near-term. Further, I want to add here that economic resilience also means strong US equities (NYSEARCA:SPY) and my view is that investors can consider US stocks on any weakness in the markets.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.