20 May 2005 The Fed May Signal A Pause In Rate Hikes
Recent economic signs point to the fact that the Fed may be close to accomplishing its goal to slow the economy enough to keep inflation under control. There are also signs in the bond markets to indicate that investors think rates are high enough. Don Hays observes that the short-term money markets (the 90-day T-bills) have consistently anticipated the Fed’s rate hikes for the past year as they hovered just above the Fed Funds rate (set by the Federal Reserve policy board). In the last few weeks, however, the T-Bill has resisted following the Fed Funds rate higher. As pointed out last in last week’s Brief, commodity prices have shown signs of topping out. Money supply growth is slow, industrial production lately weaker, and regional Fed manufacturing surveys are showing weaker activity.
Both the consumer price and the producer price indexes, released this week, showed slowing rates of growth of inflation. The prices producers paid in April were higher due to rich commodity prices, but they may have peaked. Also important, the CPI showed that manufacturers were unable or unwilling, due to competition, to pass along their higher prices to consumers.
So if the Fed is looking for reasons to believe they have raised rates enough and that inflation poses less a threat, they may have both with recent reports. The fly in the ointment is housing. Greenspan has dispelled the idea of a bubble in housing prices until recently as his warnings seem to be getting a bit louder. Recent comments have highlighted how creative and aggressive mortgage bankers have become in finding ways to lend more people more money at lower, mostly adjustable rates. The problem is they may be caught in a squeeze if rates rise by too much, worse, the overall economy could be in jeopardy if the Fed raises rates primarily to curtail mortgage growth. We suspect and hope they will pursue the regulatory path to stem growth rather than higher rates.
Also helping the inflation picture are recent trends in oil and the dollar. Oil broke below its 200 day moving average on Wednesday and closed at 46.92. It is now up slightly, but global and U.S. supplies argue for continued decline in energy prices. The dollar continues its advance against the Euro and the Japanese Yen reaching 6-month highs against both. Gold prices, which rise on inflation and other fears, fell through their 200-day moving average of $425.36 on May 11th and continue to fall. The metal now trades at $417.55.
China, in efforts to avert a trade war with the U.S. and Europe just announced new tariffs to rein in a surge of textile exports. According to the Wall Street Journal, the announcement came after the U.S. imposed quotas on imports of Chinese textiles, which have soared since a global quota system expired on Jan. 1. The European Union also is pressingChinato restrain the growth of its textile exports. The new Chinese charges take effect June 1 and could increase export tariffs for most goods by up to 400%, the official Xinhua news agency reported. The U.S. Congress is chomping at the bit to punishChinafor failing to release its currency, the yuan, from its peg to the U.S. Dollar. Allowed to trade freely, the yuan would appreciate relative to the dollar and other foreign currencies making Chinese goods more expensive. More expensive exports fromChinawould stem the tide of global trade imbalances that have occurred with artificially low valuations of the yuan. We will keep a close eye on that drama, but we take comfort in the appearance thatChinadesires free access to global markets just as muchU.S.and European markets demand that they play fairly. China’s internally imposed tariffs are a good sign, but much more needs to be done.