03 Jun 2005 ‘Conundrum’ Continues
The stock market has enjoyed a pretty good week in spite of continued mixed economic data. The S&P is up 1% so far this week while the NASDAQ has grown by 1.4%.
Long-term bond buyers and the American consumer seem oblivious to the fact that economists find it nearly impossible to project where the economy, oil, interest rates, the Fed, or inflation are headed in the coming months. Consumer confidence surveys, conducted by the University of Michigan and the government, show that the American consumer is just as eager as ever to spend his increasing income. And actual spending numbers are healthy as well.
Long-term bond prices have also continued to rise. The Lehman 7 to 10-year Treasury Index is up 1% for the week, while the 20-plus index is up 3.6% all while the Fed has raised short rates by 2%. Fed leaders say they are baffled by the disconnect between short and long-term rates. They usually rise together. Some say continued foreign purchases of American debt sustains the low yields (foreigners currently own 49% of marketable U.S. debt). Others suggest that speculators’ capitulation on their bets of rising rates have actually driven prices higher as they covered their short positions. Alan Greenspan calls the disconnect between long and short bonds a ‘conundrum.’ Federal Reserve Governor Edward Gramlich opines that “nobody has come up with any convincing story on what is the true answer.”
When Fed leaders express such uncertainty it becomes difficult to guess what their rate policy will be going forward. Most economists now think the Fed will raise the funds rate twice more by the end of August, lifting it to 3.5%. After that they may opt to take a break if inflation continues to be tame.
Recent economic reports add more confusion than clarity. U.S.employers created jobs at the slowest pace in nearly two years in May. Non-farm payrolls grew by 78,000 last month, far fewer than the 274,000 increase reported in April, the Labor Department said Friday. The department also said employers created 24,000 fewer jobs in March than previously thought. That lowered the monthly average this year to about 180,000.
But there was also good news in the report. The U.S. unemployment rate, which is based on a survey of households rather than employers, dropped a tenth of a percentage point to 5.1%, its lowest level since September 2001. The average work week held steady at 33.8 hours. Wage inflation stayed mild with average hourly earnings of workers in the private sector rising three cents, or 0.2%, to $16.03 in May. That matched the previous month’s rate of growth.
The productivity of U.S. workers grew in the first quarter at the fastest pace in nine months. Productivity, a measure of how much an employee produces for every hour of work, rose at a 2.9% annual rate compared with a 2.3% increase the previous three months, the Labor Department reported yesterday. Rising productivity offsets inflation pressures as manufacturers are able to produce more goods with slower rising costs.
Oil has recently broken out of its downward price channel on supply concerns in the second half of the year. While off 8% from its highs, it has rallied 10% from its lows of mid-May standing at just under $54.00 per barrel now. In the view of the experts I follow, the fundamentals of ample supply will one day overwhelm the shrill of traders’ unsubstantiated fears.
There’s plenty to keep our eyes on these days, but little in the way of trends. As we have said before the Federal Reserve holds the key to making or breaking this economy. Until markets know what their ultimate rate policy will be, choppy trading will continue. We are likely months away from that resolution.