BULLS & BEARS, FEAR & LOATHING

It’s only a coincidence that President Bush signed energy legislation into law today as the price of crude oil nearly touched the heretofore unthinkable $64-a-barrel mark at one point during futures trading in New York. Perhaps that’s why the president announced what everyone already knew as he put pen to paper. “This bill is not going to solve our energy challenges overnight,” he warned in Albuquerque, New Mexico just before signing the bill.


If not overnight, most Americans would settle for a solution sometime in the foreseeable future, preferably in what a middle-aged adult might term “within my lifetime.” But even that may be asking too much. It was Richard Nixon, after all, who announced all those years ago that the United States was on a mission to rid itself of the petroleum problem, namely, the dependence on foreign imported oil. America’s been on a mission ever since, and with little to show for it in terms of lowering the degree to which the country relies on offshore shipments of crude.
Today’s bull market in oil is nothing new, of course, nor is today’s rise in a barrel of crude a reaction to the new energy law. In fact, the oil market seems to be saying in no uncertain terms that no matter what the President signs, or doesn’t sign, matters not when it comes to putting a price on the world’s most valuable commodity.
In fact, the factors behind the latest ascent in crude are a mix of technical and geopolitical: various shutdowns of refinery capacities and renewed fears of terrorism in Saudi Arabia, according to Bloomberg News.
After last week’s economic news, there’s no immediate hope that the economy will provide a reason to reprice oil downward based on fears of a slowdown, much less recession. That’s not to say that oil won’t suffer a price correction, but the catalyst will have to come from elsewhere.
Is it the perfect storm for oil? It’s easy to think so, given all the smoking guns of the moment. The flip side of this view is that it’s the perfect selloff for the bond market. The yield on the benchmark 10-year Treasury Note continued rising today, closing above 4.4% for the first time since early April. True, inflation seems well contained at the moment, or so the government tells us. But that’s not likely to stop the Federal Reserve from raising Fed funds by another 25 basis points tomorrow, when the Federal Open Market Committee convenes for its regularly scheduled meeting.
And what if inflation doesn’t stay contained? Morgan Stanley’s Stephen Jen, who heads up the firm’s currency research in the London office, considered the unthinkable in a new essay. He opines that the market is “likely to seriously contemplate” a U.S. economy that “will likely grow strongly in 3Q (i.e., 5.0%), as inventories drawn down in 2Q are rebuilt.” Jen goes on to predict that with “U.S. economic growth likely to exceed the potential rate of 3.25 to 3.50% for the foreseeable future, exerting pressure on capacity, I feel risks to inflation could tilt to the upside, compelling the Fed to contemplate going beyond ‘neutral,'” which is to say rising faster and further than generally anticipated by the folks in bond land at the moment.
That’s just what the fixed-income set doesn’t want to hear. But it was just a few months back that Bill Gross, chief investment officer of Pimco, the giant fixed-income manager, predicted a range of 3% to 4.5% for the 10-year Treasury for the next three to five years. That may yet prove accurate, but at the moment the top-end of that range looks set to be give way as yields climbs higher.
The question then is whether the recent bond selloff is sustainable? And for the answer, one must necessarily look to Joe Sixpack and assess his spending habits. Dr. Ed Yardeni, chief investment strategist at Oak Associates, says Joe hasn’t yet lost his penchant for pulling credit cards from his wallet and handing them over to the nice clerk behind the cash register in exchange for TVs, cellphones and other assorted goodies. So, is the consumer able and willing to keep spending? “We think so, replies Yardeni in a missive to clients today:

The latest employment report shows that the jobs are there to keep consumers shopping. So far this year, jobs are up 191,000 per month, on average, and should at least match if not exceed last year’s 2.2 million total net gain. Wage inflation remains subdued at 2.7% year-over-year and almost one percentage point higher than core consumer price inflation. This suggests that productivity is still growing at a solid pace.

One factor that may yet slow the economy is a widespread belief that the real estate boom is in fact ending, if not collapsing. If Joe no longer believes that his three-bedroom ranch will rise in value at 20% a year perhaps he’d be inclined to give the credit cards a rest.
Yes, the economy would indeed slow if the real estate bull market corrected, opines the economics team at Wachovia Securities. “Sooner or later, and w think sooner, home price momentum will slow,” the firm counseled in an August 1 report. “When this happens we believe the economy will lose an important engine of growth.” Just don’t expect a housing bust, Wachovia adds, delivering something of a soft landing for the economy.
There’s always the possibility that consumers will eventually be frightened by rising oil prices, although to date that continues to be a paper tiger as far as our hero Joe’s concerned. No doubt there’s may be something on the horizon to revive fears of economic turmoil. Just not today, although the pessimists keep turning over rocks.