Fixed income market lacking faith in US recovery?

Outlook:

Data from Europe shows green shoots—the eurozone manufacturing PMI hit a 10-month high and the UK’s hit an 8-month high. Equities responded appropriately with a 1%+ gain in each of the major bourses. In contrast, the Tankan shows Japanese big companies contracting capital spending this year. From a sentiment point of view, Europe is happy and Japan is unhap-py.

Where is the US on this spectrum? It’s hard to say. The economy is okay and improving, but uncertainty is widespread. If people really believe in the US economy, why did the 10-year yield fall 25 bp in Q1?

If we can blame the fixed income crowd and refuse to attribute a wider malaise, what’s wrong with the fixed income crowd? As Market News reported Monday, there are liquidity issues and there is fear that when the Fed stops reinvesting proceeds, supply will overwhelm. This is probably as far away as 12 months, so it must be a huge fear and it may have a strong foundation. Bloomberg reminds us that “The average forecast from economists surveyed by Bloomberg at the end of 2014 was for an increase to 2.55 percent.”

We never claim to understand the fixed income market but surely there is something terribly wrong here. The likely culprit is a lack of faith in the US recovery. And the first quarter did bring some disappointments, to be sure. Evidently we need a steady diet of improving numbers to convince the bond gang to shove their expectations higher and more in line with the Fed’s.

Realistically, we can’t expect a start until Friday’s payrolls, although there the forecasts are not especially inspiring, with wage growth probably the same tepid 0.2%. Today we get the ADP private sector pay-rolls estimate, the ISM manufacturing index (actually forecast down at 52.5 from 52.9 in Feb), and auto sales, expected higher after a lousy winter. Frankly, there’s not enough here to inspire. Considering that it was snowing in New England on April 1, it’s not surprising that the mood is sour. Spring is late this year in more ways than one.

Meanwhile, the IMF released the Cofer report on global reserves and it shows exactly what you would expect—the dollar’s share of total reserves rose from 62.4% at end-Q4 to 62.9% at end-Q1. The euro’s share fell from 22.6% to 22.2%, although it’s bigger on the year-over-year basis, down 11%. Deutsche Banks’ Ruskin expects the euro share to fall under 20%, according to the FT, while the US share will rise to 65%. Weirdly, reserves held in yen fell by a tiny $3.4 billion. Since the yen fell, somebody must have been buying to make the amount fairly steady.

A problem arises in the emerging and developing countries, where reserves fell by $114.5 billion y/y to $7.74 trillion, the first such fall since the data series began in 1995. The FT notes “At their peak, emerging market reserves reached $8.06tn at the end of the second quarter last year.” So the question is whether we have a global savings glut, after all.

What comes next? We hate to mention it, but when the whole world has a one-sided view—euro to parity and worse—is exactly when we need to start worrying. The euro failed to make a lasting gain on good PMI data and nobody is making a big deal out of green shoots, presumably because QE looms like a giant black cloud over everything. But as Draghi says, QE gives the eurozone economy a chance to re-group and retrench. Maybe it didn’t work in Japan but it did work in the UK and US. Europe has structural differences, especially in labor markets, but it’s not clear these are fatal—yet.

We are worried about tepid data in the US perhaps removing support from the dollar. That’s not the same thing as promoting the euro, but it could give us a sideway rangy market for longer than we like. The euro could wobble around on either side of 1.0750 for a while if we do not get a catalyst.