The Federal Open Market Committee meets again today to dispatch the latest wisdom on matters monetary. By and large, the market thinks that Fed funds will remain unchanged at 5.25%.
Doing nothing may seem to be the wisest choice at the moment, but no one should underestimate the complexity of the current global economic climate. One factor that’s skewing perceptions and modifying valuations is the mountain of cash looking for a home. There is an enormous amount of liquidity sloshing around, both domestically and in foreign economies. The magnitude of the liquidity is unprecedented, and so its impact on the capital markets and economic conditions are yet fully understood.
In light of the bull market in liquidity, the main questions for strategic-minded investors are: Is it really different this time? and if so, How’s it different?

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The U.S. trade deficit has grown sharply over the years, and now routinely exceeds $60 billion a month, according to the government. By some accounts, red ink’s rise on the trade ledger portends trouble, if not calamity for the United States and perhaps the global economy when the trend reverses.
But while the trade deficit must eventually shrink, or at least stop growing, are the effects sure to be painful? Or could a reversal be relatively smooth and orderly?

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The European Central Bank raised its main rate by 25 basis points yesterday, bringing the price of money on the Continent to 3.5%. Meanwhile, Fed funds continue to tread water at 5.25%.
The spread between the primary interest rates for the planet’s leading currencies is now just 175 basis points, and a further narrowing is expected in 2007. The ongoing tapering appears set to come from both sides of the Atlantic: hikes from the ECB and holding steady at the Fed. In fact, the trend may be accelerated if Bernanke and company decide to cut rates next year, as some strategists are predicting.
The implications of a narrowing spread between U.S. and European rates are many, including increased pressure on the dollar. If euro-denominated debt continues to offer increasingly higher yields while dollar-based bonds remain more or less unchanged, forex traders and other overseers of capital will presumably adjust their decisions accordingly. The current choice stacks up as follows: a 10-year Treasury yields 4.63% vs. 3.75% for the equivalent in Germany. There’s still a premium in the U.S., but if it fades further, the realignment currently underway in the greenback could accelerate.
If the only variable in the world was interest-rate spreads, the Federal Reserve might very well decide to raise rates if only to defend the dollar. But the global economy’s more than a one-factor model. Among the additional complications: domestic inflation. On that note, The New York Times noted today, wage pressures are building. “After four years in which pay failed to keep pace with price increases, wages for most American workers have begun rising significantly faster than inflation,” the Times reported.
If the trend has legs, as the article suggested, might it complicate the Fed’s monetary policy in 2007? It might if the ECB continues raising rates, the U.S. economy continues slowing and core inflation continues rising, as it has in 2006. The scenario just described, if it remains intact, promises to bedevil the Fed, and everyone else who holds dollar-denominated assets.

Labeling a particular stretch of time ordinary, extraordinary or just plain weird is one of those tasks that fall under the heading of subjective analysis. But we’ll risk it and proclaim that ours is an extraordinary moment in time, perhaps even weird.
We speak from a strategic perspective on the subject of asset allocation. As we’ve noted before, bull markets are in blossom everywhere, in virtually every asset class. While that’s good news for calculating the profits on former investments, it raises doubts about what’s coming.
Before we go any further, let’s admit that timing the markets isn’t our forte. In fact, we’re skeptical that any one harbors such a talent, at least when measured over a business cycle or two. Our preference is one of rebalancing based on the signals Mr. Market dispenses. If asset A is up 10% over the past year and asset B is down 10%, we’re inclined to take profits from A to feed B. Yes, that’s a dangerous game with individual securities, but it carries an impressive pedigree when dealing exclusively in asset classes. The reason: asset classes don’t go bust, which is more than we say for individual securities.
But there’s always a glitch, even in the best-laid plans. The last few years have provided strategic-minded investors with a conundrum. Indeed, if everything is up, then it stands to reason that nothing is down. As a result, the prudent course for rebalancing is less than obvious and fraught with more than the usual dosage or risk.

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Forecasting next year, never mind events in 2030, is a tough job, but somebody’s got to do it.
Prognosticating America’s future for oil and related energy trends falls on the statistical shoulders of the Energy Information Administration. Predictions must be taken with a grain of salt, of course. But since the government has gone to so much trouble to crunch the data, the least we could do is take a look.
That said, the EIA yesterday dispensed its latest prophecy on the long term on the various energies consumed, produced and imported from the vantage of the 50 states. Officially, the numbers are an advance release of the agency’s 2007 Annual Energy Outlook, scheduled for publication early next year. Unofficially, the data offer another warning of what may coming.
Availing ourselves of the advance release, we went immediately to the oil numbers. Alas, we found no reason to think that all is well on the long-term energy front, as the chart below advises. Consider that the EIA predicts that over the 25 years through 2030, domestic crude oil production will advance by a paltry 0.2% a year. Consumption, by contrast, will rise by 1.0% a year over that stretch. To underscore the obvious: a large gap between production and consumption will bedevil these United States for the next generation, much as it has for the past generation. How might the future gap be sated? Imports, of course. Once again, more of the same. To wit, the EIA projects that imports will rise 1.0% a year through 2030.

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These are stressful times for investors wondering what the economy will bring next year. The stress level jumped another notch for those who read this morning’s news on October’s factory orders.
New orders for manufactured goods dropped by 4.7% in October, the Commerce Department reported today. Not only does that look bad after September’s 1.7% gain, it looks downright awful based on the fact that one has to go back to 2000 to find a bigger monthly descent in the series.
To say that something’s amiss in factory orders is to reiterate a theme that’s been bubbling for some time in the economic data. To review: the economy’s slowing. How much it’s slowing is the question, although when it comes to October’s new orders for manufactured goods, there’s not a lot of room for debate.
Deciding if October will carry over into November, December and beyond is the great question that increasingly consumes investors. Of course, to judge by equity trading of late, Mr. Market looks less than stressed. Let’s rephrase that: some investors are consumed with worry, but it may take a while to find them on Wall Street these days.

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So-called asset allocation mutual funds are enjoying a renaissance in investment flows. Along the way, the group’s undergoing an image upgrade. In the old days, the notion of owning multiple asset classes in a mutual fund that owned other mutual funds was widely dismissed as an excuse for layering fees on top of fees. A new generation of asset allocation mutual funds is attempting to reform that image. In the December issue of Wealth Manager, your editor took a closer look at the new-fangled multi-asset class mutual funds. For the details, read on….

One out of 41 isn’t a bad record, but it’s not what the optimists wanted to hear right now.
After 41 consecutive months of growth, the widely monitored ISM Manufacturing Index showed that the sector contracted in November for the first time since April 2003, the Institute for Supply Management reported this morning. New orders and production both ended growth cycles at 42 months during November, ISM added. “On the positive side, growth in new export orders continued as the weaker dollar continues to fuel that segment,” the accompanying press release advised.
But no matter how much you try to spin the numbers, there’s no getting around the fact that another minor milestone has arrived that suggests the path of least resistance is further economic slowing. Indeed, the index has slipped to 49.5 for the first time in more than three years. Any reading below 50 in the ISM index reflects a contracting manufacturing sector, which is usually accompanied at some point by a weakening economy if not recession.
There was a moment back in early 2005 when the ISM Manufacturing Index looked set to stumble below 50. More than a few analysts warned that an economic slowdown or worse would soon follow. But such forecasts turned out to be premature. Indeed, the danger passed, and the index took flight, as did the economy. But the jump was only temporary, and now it’s completed the below-50 stumble that looked imminent previously. In short, the stimulus of 2004-05 is ancient history now. The question: what, if anything, will give the economy a fresh jolt higher now?
Clearly, no one will be surprised by the news that manufacturing activity’s slowed. A number of other gauges have been telling the same story in recent weeks and months. The ISM index merely offers confirmation of what was already obvious.
The good news is that manufacturing’s fate has long been dethroned as a determining factor in what comes next for the economy overall. Ours is a service economy by far. Alas, that metric has also been showing signs of downward bias recently. But let’s not get ahead of ourselves: the ISM Services Index is still above 50, implying that the economy may remain stronger than the manufacturing sector suggests.
In any case, next Tuesday’s update on the ISM Services Index will reveal if the manufacturing slowdown is spilling over into services. Meantime, the pessimists have another data point to cite.