Inflation is said to be a monetary phenomenon, or so monetarists like to say. But today’s October manufacturing survey from the Philadelphia Fed suggests that strengthening economic activity and rising prices aren’t necessarily strangers.
“The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, increased from 2.2 in September to 17.3 this month,” the Philly Fed reported today. “The 15-point rise returns the index close to its level in August.” Meanwhile, firms surveyed reported another month of higher production costs. “The current prices paid index rose 15 points, following an increase of 27 points in September, and is now at its highest reading since November 1980,” the October survey advised. “Sixty-eight percent of the manufacturers reported higher prices for inputs, up from 57% last month. No firms reported declines in input prices.” If that wasn’t enough, the survey also noted that higher prices for manufactured goods were becoming more common, implying that higher costs are finding their way into the consumer market.
Might any of this scare the bond market? Not a chance. The yield on the benchmark 10-year Treasury Note remains as nonchalant as ever these days, ending today’s trading at roughly 4.44%, or about where it’s been all week. True, the yield’s up from around 4.0% since the end of August. Will that rise suffice as enhanced compensation for what awaits in pricing trends? Perhaps, although one can still obtain virtually the same yield in the two-year Treasury relative to its 10-year counterpart.
In short, the 10-year offers a bare 21 basis points in yield premium over the two-year Treasury. Why would any one buy the former over the latter? The answer lies with expectations, of course. Even a 21-basis-point yield advantage adds up over ten years. Of course, that’s assuming the current yield in the 10 year doesn’t rise.
Nice work if you can get it, although in listening to Fed officials of late one could be forgiven for expecting higher yields of no trivial degree down the road. “It was Janet Yellen, president of San Francisco Fed, and Governor Ferguson speaking [on Tuesday] about the importance of keeping inflation contained,” wrote Northern Trust economist Asha Bangalore in a research note yesterday. In fact, Bangalore continued, “the Fed is focused on preventing temporary price pressures from translating into persistent inflation. The risk of higher core inflation has risen as energy prices have posted sharp gains for several months and the futures market points to energy prices staying at elevated levels.”
Of course, with today’s drop in oil prices one could argue that it’s time to rethink the energy threat. But with so much conflicting data spewing forth, it’s getting harder to decide just what the path of least resistance is for the economic big picture. On the one hand, there’s reason to think that inflationary pressures will soon ebb, based in part on falling oil prices since September. In fact, crude dropped again today, at one point dipping below $60 a barrel, the lowest in three months. The oil market, at least, is starting to buy into the belief that U.S. economic growth will temper in the near future.
Adding to the belief that the economy’s due to slow, and thereby lessen pricing pressures, is today’s’ report from the Conference Board, which announced that September’s leading index of economic indicators dropped sharply last month–the third consecutive monthly decline.
But if a slowdown is coming, there’s scant sign of it in the latest batch of jobless applications. Filings for unemployment fell for the second week in a row last week, the Labor Department reported. Adjusting for the additional claims created by Hurricane Katrina reveals a labor market that retains a fairly healthy glow. “The Labor Department estimated that Katrina and Rita added 40,000 to the latest weekly claims reading of 389,000, making the clean read 315,000,” wrote David Resler, chief economist for Nomura Securities in New York, in a research note to clients today. “That keeps adjusted claims running near the lower end of its one year plus range for the second week in a row. The clean read again points to labor markets maintain their robust health.”
The bond market nonetheless betrays no fear of late. (Or is it simply looking at economics data on a selective basis?) In any case, the stock market, by contrast, looks increasingly anxious. Indeed, the S&P 500 fell 1.5% today, putting the index within shouting distance of its lowest levels since May. Meanwhile, equity market volatility is now on the rise. It’s a great time to be a trader once again, but buy-and-hold investors may face more than their fair share of choppy markets as the year winds down.