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April 18, 1997
For the first week in what seems like a long time, the bond market improved a little. Very little. Thirty-year mortgages finished near 8.375% on a "zero and zero" basis, and T-bonds drifted down to 7.08% from 7.18% a week ago.
The rally started Tuesday with the results of the March consumer price index: up only one tenth percent, core up .2%, and year-over-year up only 2.5%; now a 24-month run at that average level.
Yesterday's news from the manufacturing sector snuffed out the rally: in a .9% surge, March industrial production nearly doubled expectations. The most dangerous aspect of the report was the rate of factory capacity utilization, jumping from 83.6% to 84.1%, perilously close to the 85% "bottleneck zone," where price pressure is all but guaranteed.
This week, the spin doctors of Wall Street were selling the idea that the good CPI report for March meant that Fed would tighten no further, and the Great Scare was over.
No way.
This week was a breather, a correction within a correction. The bond and stock markets were way oversold, down too far too fast, and speculators held enormous short positions. Good news on Tuesday forced many of the "shorts" to buy back into the market, and we got a nice, technical, temporary rally.
Inflation is a "lagging" event, which must be stopped before it starts. By the time you see the whites of its eyes, you're not just late, the bayonet is already in you.
The Fed's job is to detect the conditions which will lead to future inflation, and intercept the conclusion.
Everybody at the Fed knows perfectly well that there isn't any inflation now, but their job is to protect the future.
If you've heard enough from Alan Greenspan, try another Fed governor, Alice Rivlin, a life-long Democrat and first class public servant. She said this week, "Right now, we are basking in enormous good news", noting especially that wages are increasing across the board but have not resulted in price increases.
She continued, referring to rapid wage growth without inflation: "It's not quite clear how this is happening." However, "Šthe danger is that the economy will overheat and give us inflation down the line."
It takes real guts to inflict the kind of pain the Fed has only begun to inflict when you're not quite clear on what's happening. The Fed governors may be wrong, but be glad somebody has the courage to collect the best information available, and then try to do the right thing, no matter how unpopular.
And make no mistake: the Fed is not done. They are not supposed to stop until it hurts.
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