Just as economists are getting more bearish, raising their estimates of what it will take to bring t...
Just as economists are getting more bearish, raising their estimates of what it will take to bring the US economy in for a soft landing, traders are getting more bullish.
Economists would probably be the first to admit that they have got it wrong. Traders and investors, on the other hand, are unswayed. This is the same group that is always looking to buy the dip, even through the deep, dark days of the 1999 bear market.
After all, there was no inflation. The rest of the world was still stumbling along. The worst the Federal Reserve would have to do was some tactful tweaking around the edges - rescinding the three 25 basis-point rate cuts initiated in the autumn of 1998 following Russia's default and the near-collapse of Long-Term Capital Management - and that was it.
So 175 basis points later, the consensus forecast of economists for the Federal Reserve's endpoint seems to have crept up to 7% to 7.5%. Yet traders want to buy the slowdown theory.
Stock jockeys, of course, decided long ago that the Fed has overshot already, sowing the seeds of the next recession. They latched onto that notion as soon as they were forced to give up the nonsense about technology stocks being immune to higher interest rates.
The economy is starting to slow around the edges, and the signs have been most notable in the monthly surveys from the nation's manufacturers and home builders. This is exactly where you would expect the slowdown to emerge, given these sectors' sensitivity to interest rates.
Signs of slower growth eluded the Fed's industrial production report, where manufacturing output rose a strong 0.9% and 0.8%, respectively, in March and April. Despite the weakness in durable goods orders reported at the end of May (they fell 6.4% in April), orders for non-defence capital goods showed continued strength, auguring strong business equipment spending ahead, economists said.
As well home sales simply will not quit. However, the latest surge to a one-year high in mortgage applications for home purchases probably reflects a last gasp, however, with the rise in 30-year mortgage rates to 8.62% prodding the fence-sitters into action. Retail sales were soft in March and April, but with consumer confidence undented by the stock market slide, one wonders if the spring thaw is not a pause rather than a permanent condition.
Consumer confidence soared almost 7 points in May to 144.4, a hair's breadth away from the all-time high of 144.7 registered in January when the Nasdaq Composite Index was about 20% higher than it is today. At 183.1, the present situation index is at an all-time high.
The nine-point increase in the expectations index, to a near-record 118.7, suggests consumers are not too worried about damage to their stock portfolios impinging on their life styles.
Consumer confidence historically has been influenced by the stock market and interest rates, says Chris Low, chief economist at First Tennessee Capital Markets.
What if historically higher interest rates have been the Fed's reaction to soaring inflation rather than a precautionary measure?
Rising inflation and unemployment - known as the misery index - is a lethal combination for consumers, one that Jimmy Carter used against President Gerald Ford in 1976.
The unemployment rate at a 30-year low of 3.9% is bolstering consumer confidence, even in the face of a decline in stock prices and rising interest rates.
The high level of consumer confidence notwithstanding, even if you buy the argument that the Fed has done enough to slow an economy growing at 6% for the last three quarters to a cruise speed of 3.5%, where is the impetus for a big rally in Treasuries?
The one-year-and-counting tightening cycle has been about finding a higher level of interest rates to slow an economy that has grown increasingly productive. The more productive the economy, the higher the real rate of return on investment and the higher the real interest rate required to slow things down.
Unless the Fed screws up or stocks crash in the process, the central bank is not going to be lowering the overnight federal funds rate soon.
Surely this is a tough predicament for traders, not to mention fixed-income salesmen. Already volume has withered to very poor levels. The reality of a world in which the Fed is neither raising nor lowering rates is unthinkable, not to mention unprofitable.
In that kind of environment, it is easy to see how dreams of the next big trade can take root.
Caroline Baum at Bloomberg New York
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