The 'buzz-word' dominating the financial markets is 'recession'. Investors fear that the US economy will fall into a recession, which is not unlikely. The housing market, particularly in the US, is still slumping. The credit crunch still persists and economic data is weak. Recently, the Federal Reserve Bank of Philadelphia general economic index dropped to the lowest level in seven years. And even the leading indicators showed a dramatic decline for a fourth straight month.
Last week, Ben Bernanke told lawmakers that the Fed anticipates a slowing inflation in part because of 'sluggish economic growth and rising unemployment'. In a testimony to the House Financial Services Committee in Washington, the Federal Reserve chairman signaled the US central bank is prepared to lower interest rates again, even as inflation accelerates.
The Fed 'will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,' Bernanke said.
In other words, the Fed will be prepared to keep lowering interest rates. Not surprisingly, traders see a 100% chance that the FOMC will lower the target rate for overnight loans between banks by at least a half-point, to 2.5%. Officials have cut the federal funds rate by 2.25% points to 3% since September.
These statements resulted in the US dollar's fall accelerating. The euro rose to new all-time highs above $1.50, driving commodity prices through the roof: oil above $100 and gold shot to $960. Investors showed a Pavlov-reaction to these signs of 'stagflation'. Stock markets became under pressures after the strong recovery since the lows of January.
European stock markets rose towards important resistance levels. We might expect that investors sell stocks again and buy safe havens like US T-Bonds. However, inflationary pressure yields climbed. For instance, 10-year Treasury yields climbed to 3.85% from their January low of 3.29%.
Inflation expectations as measured by the difference in yield between regular 10-year notes and 10-year Treasuries linked to consumer prices reached 2.56%, the highest since June.
Investors who think that inflation will persist might buy Treasury Inflation Protected Securities, or TIPS. Others might have another opinion and investors who do not need that protection might buy US T-Bonds. The Bonds are trading at 116 18/32, around levels of December/January. If the stock markets retreat towards the lows of January, we can expect a rally towards 123 (+5%).
The big question is: will inflation remain under control? If so, then T-Bonds can be used as a good hedge in times of uncertainty.