Iraqi Voters Get It Done, Again

In a huge turnout, 11 million Iraqis cast their ballots yesterday in their parliamentary elections, which, if the estimate holds, would put the overall turnout at more than 70%.  The main story was the lack of violence.  The Wall Street Journal notes that the election marks a significant milestone in Iraqi politics since the fall of Saddam Hussein’s regime.  It is the first political event deemed legitimate by a large swath of Iraqis, including Sunni Arabs who had shunned the political process, the Journal notes.

The New York Times said that the day’s events seemed a significant triumph for Iraqi officials and for the Bush administration, which has long maintained that the democratic process would begin to draw ordinary Sunnis away from the insurgency and encourage them to support democracy.  The near total absence of violence in Ramadi, where some local tribal and religious authorities are thought to have close ties to the insurgency, suggested that someone somewhere had struck a deal, the Times says, citing U.S. military officials.  Local leaders may be starting to push away from the insurgency in favor of political solutions.  They have held a series of meetings with the American and Iraqi command in recent weeks, primarily seeking a quick withdrawal of American troops.

Meanwhile at home, investors’ biggest question has been what the Fed would say about the economy and about interest rates.  Tuesday, to no ones’ surprise, they raised rates for the 13th straight increase by another quarter percent to 4.25%, the highest since April 2001.  But, bond and stock investors were ecstatic when they heard the Fed drop the word “accommodative” from the language of their statement.  No longer was the Fed drumming the same theme, that rates were so low that they would promote excessive economic growth, and dreaded inflation.  Investors took the view that their work was almost complete; that rates would not go much higher.

To limit the enthusiasm and likely to give Mr. Bernanke a little leeway when he takes over the reins in February, the Fed kept the word “measured” in their statement saying “some further measured policy firming is likely to be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.”  The Fed poured some water on the party pointing out that a tightening labor market and still-high energy prices were potential inflation risks.

There’s no real way other than time to tell how far the Fed will go with rates.  History has shown that they can go too far in both directions, particularly under Mr. Greenspan.  His soon-to-be replacement, Mr. Bernanke will have opinions and style of his own.  He has been vocal about his desire to be more transparent and to have published targets for inflation, but there will undoubtedly be an adjustment period for him and for markets.

While we wait, the hard data continue to reinforce the markets’ perception that inflation is not a problem.  Yesterday the government announced that theU.S.consumer price index dropped 0.6% in November, the biggest slide since 1949, thanks to the record 16% freefall in gasoline prices.  “Core” CPI, which doesn’t include energy and food prices, rose a moderate 0.2%, thanks to rising health-care and clothing costs.

Through it all the producing side of the economy continues to show remarkable strength.  Industrial production jumped 0.7% in November and capacity utilization, the percentage of production capacity in use atU.S.mines, factories and utilities, rose to 80.2%, the highest since August.  The Federal Reserve Bank of New York announced that manufacturing in that state advanced at the fastest pace in 17 months as costs (mostly fuel) declined and demand rose.  They noted that inventories were low and production was ramping up.

While the industrial side of our economy is expanding, the housing sector is now showing signs of slowing.  The number of mortgage applications submitted fell for the fourth time in five weeks indicating declines in home purchases and refinancing.  The Mortgage Bankers Association reported that applications dropped 5.7% in the week ended December 9th to the lowest level since January of this year.

Yesterday, the government announced that gap expanded to a new record in October.  The U.S.imported $68.89 billion more than it exported in October, the highest trade gap on record.  The Journal notes that many economists had expected the trade gap to shrink; and since imports detract from gross domestic product and exports add to it, many cut their forecasts for fourth-quarter GDP growth.  Morgan Stanley, for example, now expects a 3% growth rate — which would be the slowest in nearly three years — compared with a previous estimate of 3.4%.

We have discussed for weeks the possibility of a slowing economy in the coming couple of quarters, but the experts we follow do not expect a recession.  Markets have very little leadership at this point and will likely be lackluster for a while.  We look for leadership to come from the industrial and technology sectors in the coming quarters.  If demand continues, and we expect it will, inventories, which are very low will need to be replaced.  Further, as global competition keeps pressure on producers they will continue to buy technology to improve productivity and cut costs.