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June 23, 2006
The all-important 10-year T-note is crawling toward 5.25%, the level of the Fed hike due next Thursday. Mortgages are following in slow motion, although 30-year rates are still below 7.00%.
There were no economic data of note. Bonds generally followed stocks, as they have for weeks. When stocks fell apart two weeks ago, bonds assumed that the crater marked the long-awaited economic slowdown, a Fed stop and perhaps a retreat. As global equity markets have rebounded since, bonds have priced an indefinitely deferred slowdown. A 5.50% Fed in August seems a sure thing, and more forecasters (Barclays and J.P. Morgan) have projected a 6% Fed by year end.
That 6% forecast is also a forecast of a hard landing. The last two episodes at a 6% Fed (’95 and ’00) resulted in abrupt slowdowns and Fed rate cuts. The only other historical analysis that seems to apply now: the slowdown at the end of every cycle in modern times came as a surprise to everyone, including the Fed.
The leading uncertainty in this cycle is the housing market. The first stories shouting, “Housing Bubble To Tank Economy”, are now almost a year old. It may be that the economy is already entering a substantial slowdown, but masked by lagged response to Fed tightening and housing’s immense turning radius. It may also be that a five-something Fed isn’t tight enough to hurt, and that slower housing isn’t enough, either.
The secondary uncertainties: business conditions (earnings!) seem strong enough to rule out a recession; nobody really knows how close to the edge consumers are (energy and debt costs versus household adaptability); and nobody knows (or even pretends to know) how vulnerable the global trading and debt recycling machine is to a sudden slowdown here.
A whole pound full of dogs should have barked this week, but didn’t.
News that North Korea will launch a US-range missile should have guaranteed a scaredy-cat rally to bonds. Didn’t. The follow-on report that the US would try to shoot down the missile, and had begun war games in the Pacific… that didn’t, either.
Then came news that Iran had modified its didn’t-say-no response to the US-Europe-Russia-China proposal on suspending nuclear enrichment. Iran still didn’t say no, but said it wouldn’t say anything until August. Said it had to study the proposal. Drove Dubya nuts in public in Europe; anybody can see that Iran will be enriching while studying; and Russia and China may not be as aboard as advertised. The combination of annoyed Dubya and enriching Iran should have moved bonds and the oil market. Didn’t. Oil is so steady at $70 that it looks like a managed price (Saudi-managed… our good friends).
Yesterday, a senior minister in Japan said that its zero-interest policy would conclude this year. Caused not a ripple in the water, here or there. The Nikkei rallied, same-day.
Next to housing as cause of slowdown ahead, number two is supposed to be concerted tightening by central banks. Japan is draining cash, but is also still at zero; its 10-year bond at 1.87% is farther below our 10-year than it was two months ago, and the yen has weakened to 115/$ from 110. As all things are relative in currency, bond, and central bank land, the markets say that our Fed is pulling away from the BOJ on the tough-and-tight chart. Same thing with the euro down to $1.25 from $1.29, and the German bund 1.15% under our 10-year from 1.00%. The People’s Bank of China nibbled its rate another half-percent upward, but the money supply is 19% higher than a year ago, investment up 30%, and bank loans up 80%.
It seems that authorities elsewhere are less eager for a slowdown than are prognosticators here who hunger for validation of their housing-bubble theory.
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