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April 16, 2004
The rapid rise in long-term interest rates that began two weeks ago today was spinning out of control on Wednesday morning, pushed by news of inflation, and by a double-the-forecast report of March retail sales. However, a spate of contrary data this morning coupled with a pair of Fed speechettes has returned the bond market to a normal, befuddled state.
Shortly after "...CPI plus .5%... core plus .4%..." scrolled across screens, the 10-year T-note yield exploded to 4.46%, taking mortgages to 6.00%-plus, and hurting Fed-sensitive 2- and 5-year T-notes even more. That "yield-curve flattening" further closed the ARM-to-fixed mortgage gap. Market debate on the Fed's intentions centered between a June tightening and an August one, and yields implied a pricing-in of two .25% hikes by fall.
Perverse-movers confirmed the market attitude, reversing inflation bets as soon as the fact appeared. You run up the price of commodities and run down the value of the dollar until it looks as though the Fed will bust up the party, and then you get out: gold fell all the way under $400/oz, the euro is off ten cents to $1.19, and the yen is holding 108 without intervention.
All very clear. The Fed is behind, has to play catch-up; therefore remove all sharp objects from your pockets, everybody get under your desks.
Then the fog rolled in. In today's data, industrial production fell .2% in March versus expectations of a .4% gain; industrial capacity utilization was supposed to continue to move toward the 80%-plus level of a healthy economy, but fell back by .3% to 76.5%. An improving market for jobs was supposed to have taken the University of Michigan consumer confidence figure from 95.8 at the end of March to 97.0, and did not -- it fell to 93.2 (I assume in part due to difficulties in Iraq).
Fed governor Bernanke, in a post-speech aside last night: "It's early to say whether or not there's been significant movement in what we should be forecasting for inflation a year from now." Fed governor Broaddus today: "... if we see not only a bottoming of the inflation rate but an upcreep in that rate, it is going to be essential that the Fed react.... We're still some distance from that in my view."
Better confused than sorry. The 10-year has backed off to 4.37%, but at that, .17% higher than last Friday, and .70% above the March lows. Low-fee mortgages slipped to 5.875%.
Mr. Greenspan speaks to Congress next Wednesday, and the Fed meets on May 4. The Fed may still be patient, may want badly not to intercept the recovery underway, but as bond trading has showed mightily in the last three weeks, if the Fed won't react to a changed inflation landscape -- not even to begin to remove its extreme ease -- then the market will do the work for the Fed. I still think rates are in the beginning of a sustained, high-volatility rise.
Two good news possibilities: China and Iraq. China's central bank has begun to tighten credit against an acceleration in inflation there from a target of 3% to the fact of 8.3%. China's Greenspan, Zhou Xiaochuan, on Tuesday delivered a speech reminiscent of the grimmest of Paul Volcker's in '79-'80. If a bubble blows there, or a substantial slowdown develops, then global inflation pressure will quickly abate.
Three things make me think that Iraq is turning for the better. Events in March at last collapsed the Bush administration's fantasies, and now they can get to work. Second, Mr. Brahimi will appoint in the name of the UN the people to succeed the Coalition Authority on June 30, which will enhance their life expectancies, and may embolden new volunteers. Third, Gen. David Petraeus, 101st Airborne CO, has been sent back to Iraq to revive the effort to build a new Iraqi army. He is the real deal.
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