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April 4, 1997
Bonds are losing more ground this morning. T-bond yields hit 7.12%, approaching the 7.25% two-year high set in 1996, and mortgages are creeping toward 8.50%, likewise in sight of a two-year high, the 8.75% set last July.
This morning's job data could have been worse for bonds, but job growth was plenty strong to keep the Fed on its tightening track. March payrolls increased by 175,000 jobs, about as expected, but other parts of the report were more disturbing.
This is what an overheating job market looks like: wages grew five cents per hour, a 6% annual clip, and a seven-year record for a single month; in the last twelve months, wages have risen 4%, way above inflation and likely above gains justified by productivity; and March overtime pay and hours worked per week hit wartime levels, 1952 and 1944, respectively.
At this point I think we should assume that interest rates will exceed the 1996 highs recited above. The more painful question is how close we'll get to the 1994 highs: 8.13% for T-bonds and 9.50% for mortgages.
The guess here is about halfway, and there is pretty good evidence to support the hunch.
The best of the evidence: the 1997 economy is not nearly as strong as 1994, but the Fed is already almost as tight as it got at the tightest of 1994.
Okay, how strong is "strong" and how tight is "tight?"
Perhaps the single, best measure of overall economic strength is the monthly report from the National Association of Purchasing Management. It's wildly subjective: in the last week of every month, the Association asks its members, "How's business?"
Why does NAPM work so well? On the theory that purchasing managers are the first to detect increasing or decreasing sales: they are the people in any business most attuned to performance versus forecast. (It also works becauseŠ it works: if you lay a NAPM chart on top of a chart of bond yields, you'll find the two match exactly.)
A NAPM reading above 50 says expansion; near 60, a full-scale, presumably inflationary boom. From April '94 to January '95, NAPM held in a red-hot 58-60 range while the Fed raised the Fed funds rate from 3.00% to 6.00%. Shortly after the last rise, the economy fell apart, as did mortgage rates, which dropped to 7.50% in just five months.
March 1997 NAPM came in at only 55, and at that the highest since the 54 reading at the peak of 1996. Meanwhile, the Fed's tightening last week already has the Fed funds rate at 5.50%.
Therefore the hope: an already tight Fed doesn't have far to go, and a reassured bond market won't faint the way the '94 market did. Swoon, maybe; but not pass out altogether.
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