In hindsight, it seems that the US bond market knew something that the rest of us are just starting ...
In hindsight, it seems that the US bond market knew something that the rest of us are just starting to grasp: the economy really is slowing.
The 5.3% growth rate in the second quarter was a head-fake, providing fodder for those who were looking for a reacceleration in economic growth in the second half, just as in 1998 and 1999.
The gap, more like a gaping hole, in the argument was the federal funds rate, which is 175 basis points higher than it was a year ago. Everyone obsesses about Federal Reserve policy, but when it comes to the rate the central bank sets, few seem to think it matters.
After all, who cares about the rise in banks' marginal cost of funds when long-term rates are low? The important point is that the rise in the short rate seems to be achieving its goal of slowing economic activity.
Traders got a jolt recently when Milwaukee's purchasing managers reported that the local economy was in "no-growth mode" in August. Chicago's purchasing agents did them one better, reporting an outright decline in regional manufacturing activity last month. The 46.5 reading on the Chicago PMI represented the first outright contraction in manufacturing activity since January 1999 and was the lowest reading in 4.5 years.
The National Association of Purchasing Managers Index validated the tone of the regionals, slipping 2.3 points to 49.5, signaling the first outright contraction (a reading below 50) in manufacturing activity since January 1999, when US industry was recovering from the collapse in demand from Asia. The weakness in the NAPM Index was driven by the second monthly decline in the new orders index and the first decline in the production index since December 1998. The employment index fell below 50 after 15 consecutive months of growth.
Unlike the manufacturing recession in 1998, this slowdown is endogenous, not exogenous. It is a result of the Fed's actions to cool the domestic economy, not an external shock that affects foreign demand.
In other words, while one sub-50 reading isn't conclusive proof of anything, the trend in the NAPM Index has been down for the past 11 months. It is happening at a time of declining breadth: Only a small group of industries (computers, communications equipment and semi-conductors) are responsible for the lion's share of output year-to-date.
That message was driven home by last week's employment report as well. Manufacturing payrolls plummeted 79,000 following July's 56,000 increase, suggesting a possible adjustment problem connected with summer plant shutdowns. Almost every category of the manufacturing industry shed workers, the exceptions being computers, electronic components, and petroleum and coal.
What is more, the manufacturing workweek fell 0.4 hours to 41.3, the shortest in almost five years. The soft payrolls and workweek knocked aggregate manufacturing hours, a proxy for output, down 1.6%.
Outside manufacturing, things were better but by no means strong. An economy-wide proxy for output fell 0.3%, thanks to a 105,000 decline in payrolls and a 0.1 hour decline in the workweek. Adjusting for census and striking telephone workers, 138,000 new jobs were created last month, of which only 102,000 (strike-adjusted) were in the private sector.
No wonder traders and investors sold 30-year bonds in favour of two- and five-year notes as the message of the data prompt thoughts of a friendly Fed somewhere down the road.
The yield curve has been steepening for two weeks now, and last week's news just accelerated the move. With Treasury note and bond yields well below the 6.50% federal funds rate, it appears that in its collective wisdom, the market had a whiff of what was to come. That's always the way it is. When you think about it, maybe it isn't so strange. The marketplace is where the buyers and sellers come together. Individuals don't know at any given time what total supply and demand is. Mr Market does.
Caroline Baum, Bloomberg News
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