-- Posted Sunday, 4 July 2004 | Digg This Article
Friday, July 2, 2004
What a difference a few days—and a barrage of weak economic news—can make!
The majority consensus among Fed watchers and Wall Street traders of various stripes has been thus: The Federal Reserve can finally move away from its “emergency” low federal funds rate of 1% that it has maintained for some time. Starting with the 25 basis point hike it gave us Wednesday afternoon, the central bank will methodically—albeit likely at a “measured pace”—give us a number of similar baby steps over the next year or two.
Eventually, the Fed will move the federal funds rate up to one the markets deem “neutral.” Based on the most recent readings on core inflation (and I’ll pretend for the purpose of this commentary that the government’s misleading numbers are correct) this means the federal funds rate will ultimately reach a level of 4% or thereabouts. At that point, the pundits say, all will be well with the world, and the Fed will no longer be regarded as “behind the curve.” Whether we get to such a level on the funds rate is not being seriously debated; only how quickly.
Well, don’t hold your breath.
That rates will be hiked modestly has not been in doubt; after all, the Fed would blow what little credibility it has left if it didn’t do something to acknowledge that prices are rising at least a little, and that there might be some sustainability to the stimulus-induced bounce of the last year or so. But make no mistake: Greenspan and Company aren’t quite as stupid as they often sound. They do know that the economy is not on strong footing of its own accord. They do know that the various bubbles they’ve blown must not be allowed to lose their air quickly.
In short, their dovish stance on inflation is not unwarranted. This is not because prices are not rising; it is because consumption, wage growth, jobs and all the rest still suggest an economy that would have done little had it not been for the Fed’s emergency rate. The Fed will remain loathe to hike rates any more than it absolutely has to.
The last several days have in one regard ratified the Fed’s moving at a snail’s pace. China’s outlet store, Wal-Mart, has warned that its revenue growth for the second quarter will be half of prior expectations. Target also similarly warned. Two of the big three U.S. auto makers, General Motors and Ford, released horrid sales numbers. Last but not least, the Labor Department ratified this morning that the last few months’ spurt in the creation of new payroll jobs might be running out of steam.
Add to this the likelihood that second quarter earnings expectations are too high, and you have an environment where (and we’re already seeing this) many of the same people who have been on Greenspan’s case for being too slow will now be urging restraint. He will happily oblige them, particularly if in the coming weeks we get more news such as the preceding. In fact, in just 72 hours’ time the fed funds futures markets have gone from pricing in a certainty of another 25 basis point hike at August’s F.O.M.C. meeting—and an even chance of the Fed hiking by 50 basis points then—to a posture where it’s now a toss-up as to whether the Fed hikes in August at all.
Thus, for a while to come, nobody will care whether consumer prices continue to rise. After all, if Greenspan says these price rises are to some extent “transitory” (and I talk about the hilarity of that particular comment from the F.O.M.C. statement in my July issue) that’s good enough for the hoi polloi in the markets right now. They, like Greenspan, are far more interested in “growth” continuing via any means possible; and they, like Greenspan, will continue to dismiss increases in the cost of life’s necessities if it suits them.
At some point, though, I have to believe that many others will begin to wake up to the fact that we have already entered a type of environment that I call “70’s lite.” Back in the 1970’s, it was called stagflation. Growth is slowing. It will get harder to make ends meet for millions. Yet, prices will keep rising.
I am not smart enough to know exactly when this will sink into the markets, and cause traders to trash the dollar (which in recent days has still refused to confirm a new down trend) anew, sell off U.S. government debt (prices of which have rallied sharply this week) and cause gold and other dollar-contrary assets to spurt higher. It could be next week; it could be months from now. We’ll know when the technical behavior of these various markets confirms what should already be happening, but is not.
As for that last comment, consider gold for a minute. It should be up $20.00 per ounce today, given the euro’s sharp rally against the dollar, and all the foregoing. But it isn’t. It can’t even get back above $400 per ounce and stay there because (and NEVER forget this, you gold bugs out there!) the masses of investors don’t see things as we do. As I wrote in a previous commentary (“Gold’s Achilles’ Heel” – June 10, 2004) many investors who arrived late to the precious metals party only to get badly bruised in April and May have no urgency to tempt fate once more. As far as they are concerned, if the Fed is going to move as slow as frozen molasses in hiking rates, it can only be because the economy’s growth and inflation are both sufficiently muted. Thus, who needs gold?
The time will come when more of the investing public wakes up to the notion that—whatever Alan Greenspan or any one of his many apologists might say—economic activity and prices do not have to go in the same direction. When, over the next few months, the average investor does not see his cost of living decline as the economy loses more steam, reality will begin to set in. That person will then know that the world today really is like that of the 1970’s. And at that time, we’ll finally see certain asset classes acting more like the fundamentals dictate they should.
One last note about the Fed. In my view, the only reason that the dollar is not already going into the tank is because the other two major currencies—the yen and the euro—are themselves unexciting. After convincing many in recent months that its worst days were over, Japan now says it’s not so sure after all that the deflationary grip of the last dozen years has been completely vanquished. Very telling today is that the yen did very little versus the dollar.
As I mentioned earlier, the euro did enjoy a surge against the greenback; however, I view that as more of needing some place else to go (and the euro was the lesser of the evils) rather than anyone getting too charged up about the continent’s currency in its own right. It will take a technical break-out in the euro’s value to accentuate this trend; otherwise, we might very well see the euro flame out once more.
This, my friend, is one of the things Chairman Greenspan will have going for him in the months ahead as, out of necessity, he sticks with an extremely accommodative policy by historical standards. As long as Europe and Japan themselves stick with similar policies for fear their economies will weaken—and all other things being equal—Greenspan will be able to get away with staying behind the curve on inflation. And those thinking there’s still something normal about our economy—and thus think the Fed will move inexorably to some “neutral” interest rate—will be proven wrong.
To learn more or for a sample issue of The National Investor, visit www.nationalinvestor.com, or write to chris@nationalinvestor.com.
-- Posted Sunday, 4 July 2004 | Digg This Article
