REBOUNDING U.S. HOUSING MARKET MEANS TURNAROUND FOR FALLING YIELD RATES

While the U.S. Federal Reserve isn’t expected to stop manipulating the yield curve any time soon, its decision to switch its forward guidance from a calendar-based approach to an outcome-based communication strategy could make the bond market more sensitive to improvements in U.S. growth.

The world’s largest economy is gaining traction, but National Bank Financial strategist Martin Lefebvre believes the pace of job creation is still too low for the unemployment rate to fall below the Fed’s new 6.5% hurdle.

However, he pointed out that the housing market has always been a good barometer of future monetary policy due to its cyclicality and impact on employment. In fact, Mr. Lefebvre noted that turnarounds in housing sentiment can lead future adjustments in Fed policy by as much as two years.

“Therefore, the marked improvement in the housing sector could well mean that the Fed played its last card in December 2012,” the strategist told clients.

As a result, he thinks the 1.4% mark for U.S. 10-year yields witnessed in 2012 will likely remain an all-time low. Mr. Lefebvre also suggested it could prove to be a reversal point for the 30-year downtrend in bond yields.

“Although many issues are still to be resolved throughout the world, there is no reason today for yields to be almost a full percentage point lower than at the worst phase of the great recession in 2008,” the strategist said. “Consequently, bond investors should seek out more attractive interest coupons by accepting higher issuer risk, while maintaining a neutral duration for their portfolios.”