The 10-year Treasury yield continued tumbling yesterday, falling below 4.6%, the lowest since late-February. The general catalyst: mounting worries about an economic slowdown. But yesterday’s buying spree in bonds also found some unexpected support from the Greenspan effect.
Former Fed Chairman Alan Greenspan reportedly made comments Thursday evening about the prospects for a Fed rate cut, according to the Wall Street Journal. Rumors of the talk, delivered at a conference at Drake Management in New York, apparently inspired a fair amount of the buying yesterday that pushed yields lower (bond yields and prices move inversely). Nonetheless, there’s some debate about what exactly Greenspan said on Thursday. The complete Journal story (available only to subscribers) notes that “two people who attended the event where Mr. Greenspan spoke said he didn’t say anything about likely actions by the Fed, as some rumors suggested.”
Nonetheless, rumors are a potent force these days as questions swirl about what comes next for the economy. Nature abhors a vacuum, and so do bond traders. Ours is a moment when buying Treasuries first and asking questions later is the preference du jour. The fad will continue until (and if) there’s compelling evidence to rethink the trade. Meanwhile, momentum is alive and kicking (again).

The debate over whether the economy is slowing is dead. In fact, it’s appears to have been deceased for some time. Some of us may not have realized this essential fact, but the discussion of relevance has necessarily turned to the magnitude of the decline.
The latest batch of numbers confirm what the bond market has been predicting for some time: economic momentum is slowing, and more than a little. The accumulated numbers below tell the story. Of particular interest is the Philadelphia Fed index, which tracks manufacturing activity in New Jersey, Pennsylvania and Delaware. The latest report shows that the index went negative for the first time in three years, and by a surprisingly wide margin from the previous number. Meanwhile, the Conference Board’s leading index fell again by 0.2%, bringing the measure to its lowest since October 2005.
still appears intact, equities are vulnerable to a larger correction going forward. Much, of course, depends on the economic reports coming next week, which will inform Wall Street as to just how much the economy is slowing.
Indeed, next week is stuffed with scheduled releases of new numbers that could take a toll on equities. Among the highlights:
* Existing Home Sales (Sep 25, 10 a.m.)
* Consumer Confidence (Sep 26, 10 a.m.)
* Durable Goods Orders (Sep 27, 8:30 a.m.)
* 2Q GDP, final (Sep 28, 8:30 a.m.)
* Personal Income & Spending (Sep 29, 8:30 a.m.)
The slowing U.S. economy, in fact, seems to have company. BCA Research on Wednesday, citing a survey of analyst expectations on the global economy, reports that a continued slowdown is widely forecast.
The good news is that when cycles turn, volatility in prices in asset classes tends to rise as the markets struggle to digest the shift in trend. Traditionally, such periods produce attractive buying opportunities for strategic-minded investors.
Indeed, such opportunities have been notably lacking this year. Virtually all of the asset classes have been priced for perfection as it relates to their particular slice of the world. But something less than perfection is starting to arrive, and the repricing of risk in more than a subtle manner may have started. For those with the cash at the ready, the future may extend deals that are too good to pass up. If so, that alone would mark a considerable change from the recent past.
Of course, an enlightened investor must realize that if the economy slows, but by a degree that still manages to surprise on the upside, stocks could rally and bonds could suffer. Everything is relative when it comes to the link between prices and expectations. That’s why the financial gods invented diversification. Nonetheless, redeploying capital across asset classes when expected returns rise, even on the margins, is the only game in town in the long run.

There’s a higher degree of respect today for the old saying: Don’t fight the Fed.
In Fed Chairman Ben Bernanke’s first six months on the job, such counsel was thought to be of fading relevance. But the chairman’s verbal stumbles are gone while the Fed’s credibility is higher, thanks to Bernanke and company’s forecast that a slowing economy would complement lower inflation. So far, that prediction has proved to be accurate, and Wall Street couldn’t be happier.
In fact, yesterday’s decision by the central bank to hold Fed funds at 5.25% was widely expected. Fed funds futures have been predicting another pause for weeks.
But this new world order of respect for the institution that ultimately controls inflation’s path is contingent, as always, on what happens next. From an investor’s perspective, the future holds more than a few challenges, and perhaps some volatility in pricing because expectations in the present are fairly high and rising.
Investors seem inclined to believe that the so-called Goldilocks economy is assured–not too hot and not too cold. In this vision of future bliss, economic growth will slow enough to keep interest rates from rising, but growth will not tumble so much as to bring on a recession. Meanwhile, inflation will moderate to just the right level to stave off deflation while giving the Fed room to continue pausing and perhaps even begin cutting rates.
In a world where the yield curve is inverted, expecting perfection may be asking for more than the financial gods can deliver. A three-month T-bill currently yields 4.92%, about 20 basis points above the rate on a 10-year Treasury. Then again, perhaps this is the international signal that perfection is coming in economic and financial spheres. One has to keep an open mind in the new world order, even if we’re keeping one hand on our wallets.
In any case, jubilation dominates trading in stocks and bonds. The S&P 500 yesterday on an intraday basis probed heights last witnessed in February 2001, while the 10-year yield yesterday briefly dipped to its lowest (~4.71%) since March.
Some of the buying is inspired by the correction in commodities, notably energy. With the froth coming out of prices for oil, gasoline and natural gas recently, the money is being redeployed in stocks and bonds.
But amid all the euphoria that’s now sweeping Wall Street, it’s worth remembering that the Fed still has work to do. The core rate of inflation still remains too high to ignore. Meanwhile, labor costs seem to be perking up, delivering what may turn out to be a headache for monetary policy in the near future.
“All the wage data show an acceleration to one degree or another yet the policy makers do not acknowledge that” in yesterday’s FOMC statement, Mark Zandi, chief economist at Moody’s Economy.com, told the New York Times today. “That is suggestive of a more dovish Federal Reserve. The small changes in this latest statement all suggest that the Fed will not be raising interest rates anytime soon. In fact, you can almost make the case that they are trying to drive expectations in the other direction.”
To be fair, the Fed’s statement did advise that “some inflation risks remain” and so “additional firming that may be needed….”
But for the moment, warnings fall on deaf ears on Wall Street.

It’s too soon to declare that the Fed has once and forever stamped out the inflation embers, but it’s clear that the central bank has won the current battle.
The concern that consumer and producer prices would spiral upward while the Fed kept interest rates flat has been demoted, if not yet completely quashed, as a topical worry. The FOMC meets today and will likely declare that the price of money can remain as is. In sum, the debate that the liquidity unleashed in the recent past is about to show up in official inflation numbers is dead for the moment. But the thornier issues of deciding where all the liquidity went, where it will go, and what it means for future price trends remains alive and kicking.
In an earlier era, the hefty injection of liquidity into the U.S. economy that prevailed in the years after 2001 would have delivered more of an inflationary kick, as tracked by consumer price gauges. That hasn’t happened, but the reason has as much to do with deft central banking as it does with disinflationary and even deflationary winds blowing in the global economy.
The rise of emerging market economies in recent years, as The Economist points out this week, has been a major force for keeping broad measures of inflation relatively contained. As the survey asserts, emerging nations have delivered both a fresh and healthy dose of cheap labor and cheap capital to the world economy to a degree that’s unprecedented. In turn, prices for a number of goods and services, along with wages, have stayed lower than they might otherwise be in the U.S. and elsewhere.
The Fed and other central banks, as a result, have found it easier to keep interest rates lower and permit liquidity to rise higher than prudence might have allowed a generation ago. But while the liquidity production hasn’t come back to bite the economy, it’s had an impact. Where has all that liquidity been going? It’s not obvious, if one looks at the broad measures of inflation, as yesterday’s producer price index and last week’s consumer price report remind. But rest assured, the extra money the Fed has so generously printed has gone somewhere.
In the late-1990s, inflation arguably showed up in stock prices, which ran skyward. When the equity market collapsed in 2001 and 2002, cash found a new home in real estate. The bull market in housing in particular is said to be a boom of unprecedented proportions. Of course, that boom is now in the process of unwinding.
Liquidity has also migrated into emerging market economies, which hold 70% of the world’s foreign exchange reserves, according to The Economist’s latest world economy survey. That’s extraordinary for a number of reasons, starting with the fact that while the lion’s share of the planet’s reserves are in emerging economies, those nations represent less than 20% of the world’s stock market capitalization.
Imbalances are all the rage these days, and that extends to the extent that a large chunk of the liquidity held by the likes of China and India has migrated back to the United States in the form of funding of the country’s current account deficit via purchases of Treasuries and other assets.
If the past is any guide, however, excess liquidity is a transient form of capital. Expecting it stay put may be expecting the impossible. If so, what does the future hold when the liquidity seeks out greener pastures? It’s a timely question these days as some of the liquidity starts to come out of real estate and the global economy seems poised for a downshift in growth. Thus the question du jour: Where will liquidity go next? Perhaps it’ll flow back into real estate, or gravitate back to stocks, or work its way into the economy so that the general price indices start moving up after all. Or, maybe the liquidity will surprise everyone and foment repercussions that no one can yet imagine.
Fed Chairman Ben Bernanke is on record as saying that the world has been awash with a global savings glut. That glut has been helpful to U.S. monetary policy so far. After Bernanke and company are done celebrating today, perhaps they might ponder if the global savings glut will continue to benefit the American economy, or if something might change.

DUE TO A TECHNICAL GLITCH WITH OUR SERVER, WE WEREN’T ABLE TO PUBLISH UNTIL LATE THIS AFTERNOON. THE TECHNOLOGY GODS APPARENTLY ARE ANGRY WITH US. IN ANY CASE, HERE’S THE POST AS WRITTEN THIS MORNING…
Last week’s report on consumer prices for August was encouraging. This morning’s news on wholesale prices is even better.
Producer prices rose just 0.1% last month, the Labor Department announced. Subtracting food and energy from the mix revealed a core PPI that decline 0.4% in August. That’s the second month running that core PPI fell. Falling car and light truck prices were the main factors weighing on producer prices.
Coming just a day ahead of tomorrow’s FOMC meeting, today’s news will likely deliver the extra muscle to insure that the Fed keeps interest rates unchanged. In fact, traders are starting to nibble at Fed funds futures this morning, providing what may be a preview of anticipating a rate cut in October.
Helping raise the prospect of a rate cut down the road is the Commerce Department’s report this morning that housing starts dropped again to an annualized pace of 1.655 million–the slowest pace since April 2003. No one can doubt that real estate is now in the midst of something more than a temporary stumble.
Even so, the bond market apparently had the jitters yesterday, driving the yield on the 10-year Treasury up to nearly 4.85% at one point–the highest since late-August. But optimism has since returned, and in early trading this morning the 10-year’s yield is again fallen below 4.80%. By the end of the week, even lower yields are expected.
For the moment, the optimists and doves are heroes. Meanwhile, Bernanke’s star burns brighter this morning. Inflation is still a long-term enemy and the path of least resistance with a government and an economy that are hard wired to spend more than they take in. But such worries have been banished to the deepest recesses of Mr. Market’s collective mind.
The trend is said to be your friend. For the moment, there’s plenty of incentive to go with the flow.