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July 30, 2004
Mortgage rates are still near 6.00%, held there by the 10-year T-note trading in the 4.50% range, well below the 4.80s during the worst of the April-June stretch -- the one in which the Fed was presumed to be falling behind the curve of inflation and an accelerating economic expansion.
We know now that it was not behind. Further, in the rolling second-, third-, and quadruple-guessing of the markets, a lot of bond market people now wonder if the Fed might have been ahead of the curve, raising its rate into a slowing and fragile economy. Stock market types are still the soul of optimism, and so is Mr. Greenspan, his testimony to Congress last week totally dismissive of economic worry.
Perceptions of the economic curve blew up with poor payroll data on July 2, but inflation concerns persisted until today's April-June GDP deflator fell back to an annualized 1.8% from 2.1% in the 1st quarter. The GDP data showed an overall slowing to 3.0% growth in the 2nd quarter from 4.5% in the 1st, but internal aspects were disturbing: spending growth by consumers fell all the way to 1%, its lowest reading in three years. The overall 3% growth was propped by a build-up in unsold inventories and business spending, neither sustainable unless the consumer revives.
Consumer suppression is not hard to figure out. Economic skeptics have pointed to the end of tax-cut goodies, and soon-to-be $2.50 gasoline is burning a huge hole in the average wallet. Those with high incomes, high enough to buy a home, may forget that the median household income in the US is only $42,000, and a doubled household energy bill has very quickly extinguished other consumption.
At some completely unpredictable moment, energy prices will crest and fall back. The 1973-74 and 1979-82 oil shocks taught us that a higher range of price would ultimately generate more production and less consumption; however, I don't think anyone knows the boundaries of a new range. In the next decades oil could bounce between $30 and $50/bbl, or something worse; but we do know that there are a lot more and bigger, healthy and growing economies ready and able to bid against the US for increasingly scarce supply than there were twenty years ago. We also learned back then that one of the solutions to an oil-price shock is a nasty recession.
Consumer confidence surveys are all right; a tail-off in orders for durable goods seems more a return to reasonable trend after a too-hot spring than a serious slowdown; the Fed's "beige book" was tepid, but not terrible; and home sales are cruising along. However, the evident slowing in the economy makes Mr. Greenspan's situation more complicated. He is determined to get the overnight cost of money (the Fed funds rate) back to neutral, somewhere in the vicinity of 3.00% from 1.25% today. Too much stimulus from a too-low rate brings its own hazards, but a sustained quarter-point-per-meeting water torture is going to be hard to justify (and possibly to survive) if the economy continues its "soft patch", the stock market sinks, and inflation remains invisible.
In his testimony last week, the Chairman sounded out of character to me. He understands as well as anyone how little we can know about the future, yet he spoke of threats to the economy in categorical, nearly contemptuous terms, insisting on the rectitude of his course to higher rates. Maybe he wanted to intercept excessive bullishness in bonds, or maybe to engrave his alertness to inflation threats.
Senatorial probing for the precise location of "neutral" got this from the Chairman: "You can tell whether you're below or above, but until you're there, you're not quite sure you are there." The Chairman has earned an immense reservoir of respect, but the I-know-best-without-your-help act is going to wear very thin, very fast unless July data due next week show that June was an anomaly.
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