THE RESILIANCE FACTOR

Today’s report on the economy’s third-quarter performance is the first major data release since Ben Bernanke was named as Fed Chairman Alan Greenspan’s successor. Will the report from the Bureau of Economic Analysis impact next week’s FOMC meeting at the Fed?


The central bank looked set to raise Fed funds to 4.0% from 3.75% on November 1 even before Bernanke official become the Greenspan heir, or so the futures market was predicting. Today’s release of the advance estimate on third-quarter GDP doesn’t provide any fresh reason to rethink a future of higher interest rates, and arguably provides fresh reason for arguing for something more than a 25-basis point rise at the next monetary confab.
The economy grew by a 3.8% real annualized rate in the third quarter, up from 3.3% in the second quarter, BEA announced. The new GDP numbers also lend confirming evidence for what everyone already knew: inflationary pressures are on the rise. Consumers paid prices that were 4.0% higher in the third quarter, up from a 3.3% rise in the second quarter, the GDP report noted. As with the consumer price measures, however, the core rate of price changes in today’s GDP news shows a lower inflation rate after taking out food and energy: a relatively mild 2.2% rise vs. an even milder 2.1% previously.
“Holy Katrina! The economy weathered two major hurricanes and in spite of that showed accelerated growth,” Ken Mayland, president of ClearView Economics, said in a story this morning from AP via ABCNews.com. “I think what this shows is that fundamentally the economy was and is in really good shape.”
Like Greenspan, Bernanke will have to consider the signs of sustained economic growth and elevating top-line inflation pressures and decide if it’s appropriate to look only core (i.e., lower) core inflation rates. Meanwhile, there’s the issue to ponder of whether to take seriously the signs that Joe Sixpack is becoming gloomier by the month. Today’s release of the University of Michigan consumer sentiment index for October is the latest clue that consumers may be rethinking their profligate ways. The widely followed index slumped again this month, the third monthly decline in a row.
“Hurricane disruptions, soaring energy prices, and an endless string of Washington scandals and missteps are continuing to depress the [consumer] survey results,” Michael Englund, chief economist for Action Economics, told MarketWatch.com. In the same article, another practitioner of the dismal science went further, opining that the third consecutive decline in this sentiment index may catch the central bank’s attention: “…the direction is clearly something that the Fed can not be pleased with,” said Stephen Stanley, chief economist for RBS Greenwich Capital.
The bond market, meanwhile, has already priced in the expected interest-rate hike on November 1. Or, if you prefer, the fixed-income set is unmoved by the latest GDP report. In either case, the yield on the benchmark 10-year Treasury logged a fairly uneventful session today by rising ever so slightly to 4.57%. In the bigger picture, however, yields are very much on the march, with the 10-year’s current yield sharply up from 2005’s low of around 3.8% touched back in early June. The bond market may or may not decide to continue asking for a higher premium to hedge the future, but it’s clearly considered the issue of late.
The stock market, however, had a change of heart, at least for a day. The S&P 500 jumped 1.3% on Friday. It’s too early to tell if this is something more than noise in an otherwise declining market. Nonetheless, it’s no mean feat to pull a rally out of a hat in after a week that gave us an indictment at White House, the withdrawal of Supreme Court nominee, a very public reminder of the approaching change of Fed leadership, ongoing fallout from the devastating hurricanes, and an energy bull market that continues to roll and thereby test the consumer’s endurance for financial pain.
The fact that GDP continues to impress is, well, impressive with so many negatives floating about. Equity traders can be forgiven for staying bullish, much to the chagrin of pessimists.
Hope, in sum, still springs forth. But so do the variables of contradiction, including this little tidbit to chew on over the weekend: On the one hand, short rates are rising, and more of the same is expected in Greenspan’s remaining months. But a look at money supply trends of late suggest that the production of greenbacks isn’t necessarily drying up, at least not as quickly as some might have expected. In fact, the rate of output is by some measures gaining momentum. Consider, for instance, that the 13-week average of M2 money supply (as published on a weekly basis) advanced by 0.12%, which tied with the previous week as the highest rate of increase in several months. That’s nearly double the rate of ascent from the comparable figure for August 1. Similar, if less overt trends can be found in four- and one-week M2 averages in recent months.
A rising Fed funds rate and an accelerating pace of increase in money supply are the strange bedfellows of macroeconomics. One’s eventually got to give in order to extend aid and comfort to the other. Some investors think they know which one will give first. But given all the debt that the government must finance, and social programs it must fund in the years ahead might there be an alternative monetary plan that lurking in the shadows that necessity forces upon an otherwise well-intentioned government? It may be impolite to even suggest such things in proper financial company. Nonetheless, we’re just boorish enough to think that someone should bring it up in Bernanke’s Senate hearings next month.