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April 11, 1997
What a lovely spring break: two whole weeks when it looked like the Fed might be wrong.
Welcome back. This morning's news has reinforced the markets' fear of another Fed move next month, and another before summer's end. T-bonds have hit 7.18%, and "pointless" 30-year loans have arrived at the 8.50% mark.
One-year T-bills reached 6.02%, so next month's one-year ARM adjustment notices will go out at 8.75%. Terrific deal, there.
What was so bad about today's news? None of it, really; and that's the bad news: a market that crashes on such thin evidence is destined to have more bad days, and soon.
There were two reports today: producer (wholesale) prices, and retail sales.
Producer prices actually fell .1% in March, but the "core" rate excluding food and energy prices jumped .4%. Theoretically, the core rate is a better predictor of future inflation than the overall index. However.
The core rate rise was distorted by a spike in the price of airplanes, which is hardly as central to prospects for inflation as the price of oil, which is trading at $19.50/bbl, 25% under the $26 peak last winter. That peak was the main reason rates started to rise in December. If high oil prices were a problem, why don't low ones help?
Retail sales in March were expected to rise .5%, and instead rose only .2%. The weakness should have helped, but gimlet-eyed traders noticed that retail sales would have risen .5% if you ignore weak auto sales, a theoretically temporary aberration. Also, February retail sales were revised from a .8% gain to a 1.5% leap.
Wait a minute. Since when do car sales not count? If they're down, they're down; aberration or not. Furthermore, you've got a huge deceleration in retail sales from February to March; and if anything was distorted, it was February's strength, propped by unusually good weather nationwide.
Airplane prices and weakening retail sales wreck the markets? (Dow down 126.04 at this writing; correction now about nine percent. Do I hear fifteen?) What gives here?
An old argument: do bonds fear inflation, or the Fed? One side believes the Fed forever fears and fights imaginary inflation, and bonds in turn fear the Fed. The Fed faithful (like me) believe that modest rises in bond yields are a minor cost of the larger benefit of inflation containment. If the Fed didn't tighten, rates would really explode.
Since we don't have a small country on which to conduct vivisection experiments, the argument lives on. However, Fed-believer that I am, the bond market is trading now on Fed-fear, not real news. The fear is well-founded.
Right or wrong, the Fed's a' comin'.
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