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July 16, 2004
All the scratchin' and itchin' out there doesn't have anything to do with bug bites. Nope, markets have the burr-under-the-saddle, sat-on-a-tack fidgets because nobody can figure out what happened to the economy in June.
The people can't figure it out, but the bond market says that it can, and has: the 10-year T-note fell to 4.36% today, down .12% overnight to a three-month low. The lowest-fee mortgage packages are now crossing under 6.00%, quotes appearing at 5.875%, as the whole "long end" of the yield curve has dropped a half percent from the peak of the Fed fright one month ago.
The economic optimists (many, if not most, associated with the stock market), insist that June was just a breather, a healthy pause after a screaming spring.
They dismiss the decline in June industrial production (off .3% versus expectations of a .1% gain) as a normal retrenchment magnified by a drop in utility production in a cool month. They say the 1.1% decline in retail sales was due to auto makers backing off incentives, and to cool weather dampening ardor for summer clothes. Arch-boosters swore that the rest of the retail decline was traceable to tens of millions of people taking time out from shopping to watch the Reagan funeral.
The University of Michigan consumer confidence reading stayed in the mid-90's, and surely, if there were really anything wrong with the economy or job market, confidence would fade. Statisticians made a month-long hash of unemployment claims, but there is no new anecdotal weakness in business hiring plans.
The central argument for optimism, as one guy said: "There is no reason for the economy to poop out here."
Others see things other ways. Business inventories have suddenly bloated, simultaneous with reduced sales projections, a combination that almost guarantees a further slowdown in new production. The industrial production number may not have been so bad, and distorted by utilities, but there is no pleasant explanation for a decline in the percent of capacity in use. The 77.6% in use in May was expected to continue a brisk rise toward a healthy 80%, at least to 77.8% in June, and instead flopped to 77.2%.
Consumer confidence numbers do track jobs, but they have also tracked Iraq, confidence rising and falling in inverse proportion to American casualties. The newly invisible Mr. Rumsfeld would hardly announce such a thing, but it appears to me that US forces have pulled back from offensive operations -- maybe to give the new government a chance, but for whatever reason keeping American casualties down.
Energy prices are still high, chewing into our economy, and it should be clear by now that the altitude is not mere speculation or terror mongering. Global production capacity is matched by current demand, and nothing but high or higher prices can stem that demand -- nothing except a general economic slowdown.
Economic skeptics have pointed for two years to the moment at which all the tax cut and low interest rate incentives would be in place, and wondered if that moment would not be a perfect spot for the economy to poop out. The moment? Just after the last of the over-sized tax refunds were received in May.
The optimists and skeptics agree on only one thing: this week's PPI and CPI data show that inflation is not running away from the Fed. The core rates are behaving very well, just below 2% annualized.
We won't get definitive July data until the end of the first week of August, but this enormous June rally in bonds is a statement in itself. A 10-year T-note below 4.50% says the Fed's pace will be "measured" with the hundred-foot tape, not the .25%-per-meeting ruler, and a Fed funds rate higher than 2.00% in a year or more is not on any bond trader's worry-screen.
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