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June 17, 1988
Though rates dropped early in the week, the bond market sold off later, and we are close to unchanged since last Friday. Bonds are doing poorly this morning even though Housing Starts are reported to have fallen 12.2% last month. The market is looking for another round of Fed tightening; despite an absence of news of dramatic inflation or an overheating economy, investors are trying to protect themselves by selling heavily whenever the market rallies.
The Merchandise Trade deficit fell a startling $2 billion in April, and was the direct cause of Tuesday's explosive bond rally. However, the First Quarter Current Account Trade balance showed record growth on Wednesday, and our rally came unraveled. The Current Account includes services and financial flows, and deterioration here is a reflection of growing American indebtedness to the rest of the world (a Toyota sold to the U.S. creates a merchandise deficit, whereas an interest payment on a Treasury bond to a Japanese investor creates a current account deficit).
Retail Sales in May rose a weak .1%, and Industrial Production rose a mediocre .4%. However, Capacity Utilization rose .2% to 82.9%, unemployment insurance claims fell quite a lot, and the drought in the Midwest is continuing to drive up commodity prices. The drought is bad enough that the Mississippi has the lowest flow at St. Louis since records began 127 years ago.
The bond market is very bearish, but even if the Fed does tighten another notch, government loans should trade close to par at 10.5% into the summer. However, points are likely to bounce around a lot, so take every opportunity to lock in during rallies like Tuesday's. One of the few reliable short term trading guides is the contrarian view: whenever the market moves sharply up or down, it is likely to reverse itself for a little while no matter what the Fed or economic news may suggest. Bonds rose over two points on Tuesday: it should be no surprise that they fell back on Wednesday. Anyone who saw the rally saved a thousand bucks on a home purchase by locking.
I will be out of town at my brother's wedding Thursday, June 23 through Tuesday June 28, so no Headlines next week. I'll be in touch with my office, and my associates will pinch hit if you need help.
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