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March 10, 1989
The bond market is unhappy with this morning's releases: Unemployment fell to 5.1%, a 15 year low and a bad surprise, and NonFarm Payroll grew 289,000. The wage data buried in these job figures indicates persistently rising inflation; after two weeks of improving rates, look for a tough next week.
There was only one other important piece of economic data last week: Purchasing Managers reported the second consecutive decline in their index after 28 consecutive increases. Not a definitive slowdown trend, but at least a trendlet.
If you only have time to look for one report, this Purcahsing Managers one may well be the most accurate and easiest to understand. If you think about it, purchasing managers are among the first to hear of price changes, slowdowns in sales, accumulations of inventory, and slowdowns or speedups in deliveries of orders due to an overheating or slowing economy.
Despite early indications that the economy is slowing, an economic slowdown will be a victory in a war which the Fed has already lost. Had the economy slowed last year, we would have gotten rate relief by now. Instead, the economy has been allowed to grow too long and too much, and now it is inflation which must be slowed.
Inflation is harder to slow than the economy. Expectations of higher prices are thought to be broken only by pain of liquidation: defaulting borrowers, mostly. In order to break the wageprice spiral, the Fed will have to continue to raise rates, or at least leave them as high as they are. The Fed will not be able to ease as the economy weakens, but will have to wait until inflation breaks. This Fed trap is the source of most recessions.
You can limit client risk by changing your strategy accordingly. The bond market will now react to inflation data much more strongly than to the normal run of data on economic strength. As inflation numbers will likely be lousy for some time, protect clients by locking before any release of consumer or wholesale prices (due out next Friday). Take advantage of good market days caused by evidence of economic weakness: the bond market will rally temporarily on such news, but the Fed ain't about to back off.
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