November 3, 2005
WAITING FOR THE NEXT BIG THING
BCA Research advised on Tuesday that an economic slowdown was coming. The bond market, the research shop continued, would see the approaching stumble before the Fed got wind of the trend. "Bonds have already discounted a lot of hawkish Fed rhetoric in recent weeks. Moreover, the selloff at the long-end of the Treasury curve is growing tired, according to our short-term momentum measure. Valuation has improved and there should be strong technical support near the March high of 4.65%."
In fact, the 10-year yield as we write is 4.63%, or just about the highest since March. Will this range hold, as BCA predicts? Or, is a breakout to higher yields the next big change for the fixed-income markets?
Judging by this morning's release of the ISM's report on non-manufacturing activity for October there's reason to think that yields could take out the March highs. The non-manufacturing index rose to 60 last month, moving sharply higher from September. The rebound returns the non-manufacturing sector--which includes such industries as construction, retail trade, and finance & banking--to a pace of growth on par with the first half of 2005, writes David Resler, chief economist for Nomura Securities in New York, in a research note today. "Overall, the sector's business activity is steady," he opined.
Is this what the onset of an economic slowdown looks like? Perhaps not, although if you're intent on finding support for the BCA gloomy forecast, consider today's release of orders for manufactured goods to consider, which fell 1.7% in September, the Census Bureau reported. That's the lowest since July. But this is a thin reed for rationalizing that the economy's set to stumble since the Katrina and Rita hurricanes probably caused widespread shipping delays, which raises questions are the relevance of September's factory orders.
Meanwhile, this morning's news that retailers had a surprisingly strong month in October is harder to dismiss. The 4.4% rise in same-store sales last month, according to the International Council of Shopping Centers, is hard to interpret other than to recognize that Joe Sixpack's still reaching into his wallet and confounding some dismal scientists who expected less our hero on the subject of spending. "This is great stuff," said Richard Hastings, retail analyst at Bernard Sands LLC, speaking of the retail numbers via a story from Marketwatch.com. "It shows again that you can't bet against the consumer."
But if Joe keeps on buying, which in turn keeps the economy bubbling, the Fed's likely to keep pushing up short-term rates, an action that's seems to have finally caught the attention of the fixed-income set.
Of course, higher interest rates, if they ascend far enough, will eventually deliver the outcome that BCA predicts. The timing, however, is open to debate. To be fair, BCA's hardly alone in its forecast that a slowdown will arrive sooner rather than later. Bill Gross of Pimco, in his November "Investment Outlook," published a chart showing that over the last generation, when the spread between the two-year and ten-year Treasuries has narrowed to roughly parity, as describes the current spread, recession followed.
Is history fate? Perhaps, but there are more than a few things that have changed in recent decades to insure that obvious trends may not be so obvious after all. Ergo, there's a surplus of things that could go right--or wrong in a global economy that's become amazingly complex. In the meantime, there's a number of question to which no one yet has satisfactory answers.
Consider, for instance, the topic of a global savings glut that Ben Bernanke, the next Fed chairman, has discussed. Does such a glut in fact exist? And if it does, are the implications cut and dry? On the one hand, a surfeit of cash sloshing around the world in search of a home implies that interest rates will be lower than they otherwise might be. But as a Wall Street Journal story today (subscription required) points out, excess cash may be imprudently promoting risky behavior and thereby setting up the capital markets for another bubble-popping event. Then there's the debate over the Bretton Woods II, a reference to the currency markets that allow (promote?) a relatively strong dollar in the face of rising government and consumer debts in the United States. Daniel O'Connor of Catallaxis describes BWII "Stable Instability," although the capital markets, for the most part, think it's just fine as it allows America to finance its debt and keep Joe spending to a degree that breaks every rule we learned in economics 101.
What does the bond market think of all this? For the moment, the jury's still out. That said, the 10-year's yield is inching higher. Our guess is that it'll take another catalyst to trigger a breakout to higher rates, or pull yields down sharply and thereby keep the trading range of recent months intact. What might this catalyst be? The choices, it would seem, are infinite at the moment.
Posted by jp at November 3, 2005 12:31 PM
...at 51 years young, with over 20 years experience on Jet-skis (from the days when they required fitness (ie. "stand up" to operate models only)) I enjoy your terminology of "sportboy"! Thank you. My usage of Jet-ski is analogous to the idea that a smaller unit is more easily redirected when changes are required. Having said that, high-performance operation of any instrument (including an investment portfolio) demands a sober, "eyes-wide-open" mentality. I'm relatively certain that your "hangover" and "rocks" were analogies as well... Thank you for your comments, ksb; thank you for this format J.P.
Posted by: lotek at November 4, 2005 10:40 AM
last comment directed to lotec
Posted by: Anonymous at November 4, 2005 3:58 AM
I read all the time about "sportboy" jet-ski dudes and their folly. Wake up, or you too will kill yourself by running into a tugboat. The world is intoxicated with fools. The hangover.....is just around the the bend. Watch out for rocks too
Posted by: ksb at November 4, 2005 3:52 AM
...new paradigm? Ha, ha! One of the things I find so interesting in the recent market trends is the frustrations wrought unto conventional wisdoms. Are you aware of the ancient Chinese curse; "May you live in interesting times"? In my humble opinion, the playing field has been leveled for relatively intelligent players such as myself. J.P., I love your postings, and I visit your site nightly (among others), and in doing so I find more indecision amongst professionals than I can believe! I find relative hedge fund under-performance, flat broad market indices and bond-traders grudging reluctance to acceptance of the times extraordinary!!!
It gives me solace to be a Jet-ski in a world of tug boats and battleships...
Posted by: lotek at November 3, 2005 10:38 PM