Foreign exchange traders are nearly giddy at the prospect of higher interest rates in the United States. The U.S. Dollar Index jumped sharply today in the wake of yesterday’s 25-basis-point rise in the Fed fund rates. But there’s more to the dollar buying than is dreamed of in quarter-point rate hikes. The dollar bulls, a feisty if contrarian group that’s run up the U.S. Dollar Index to its highest in about a month, are looking to the FOMC meetings scheduled for May and June for aid and comfort, perhaps in the form of 50-basis-point hikes.
The primary source for such expectations, warranted or not, is the Fed, which yesterday announced what everyone already knew, namely, that “pressures on inflation have picked up in recent months and pricing power is more evident.” It’s a short jump from that curt observation to anticipating a 50-basis-point jump in the Fed funds when the maestro’s banking troupe convenes again on May 3.
“Inflation is percolating higher and the Fed will aggressively respond to that,” Mark Zandi, chief economist at, tells the Associated Press via In fact, Zandi predicts that Fed funds, currently at 2.75% after yesterday’s hike, will be 5% or so by late 2006.
Perhaps, although the case for higher interest rates, at whatever pace of increase, certainly looks prudent if corporate earnings continue to bubble, as Ed Yardeni predicted in a report to clients earlier this week. “I am starting to think that profits growth might be stronger than expected this year,” writes the chief investment strategist of Oak Associates. If his outlook proves accurate, profits in S&P 500 companies will climb 12% in 2005 and 6% next year. His emboldened optimism is hardly irregular, he says, claiming that “profits recoveries tend to be stronger than expected.”
A “boom in world trade” is the reason this time around, Yardeni continues. trade. “U.S. manufacturers are shipping more exports and distributors are distributing more imports. U.S. manufactured exports now account for 15% of factory shipments excluding petroleum products. That’s up from 14.3% and 12.7% five and 10 years ago.”
But not every corner of the free market agrees. Indeed, the sharp drop in oil prices today is premised partly on the notion that an increasingly aggressive Federal Reserve will slow growth, thereby shaving demand for crude, at least temporarily. The bond market, for what it’s worth, seems to side with the oil traders and the higher-rates-will-slow-the-economy school. The yield on the 10-year Treasury Note slipped today to under 4.6% after shooting above that mark yesterday for the first time since last July. It’s only been a day since the fixed-income set saw their lives flash before them, but that’s not necessarily a reason to abandon a 20-year-old bull market in bonds.
One day a trend does not make, of course. But in light of today’s consumer price index report for February, the forces calling for tightening the monetary strings are gaining momentum. Indeed, the CPI advanced 0.4% last month, the highest monthly advance since October. And while the year-over-year CPI doesn’t look threatening by the standards of late, the Fed is surely paying close attention to the bull market in the core (less food and energy) CPI rate, which climbed 2.4% over the past year in February—the fastest pace in nearly two years.
“We are seeing price pressures, especially non-energy components, working into the retail level,” Richard DeKaser, chief economist, National City Corp. explains to Reuters today by way of Netscape News.
The new new era of the post-bubble world has arrived in earnest. Contradictions, cross currents and the mixed signals born of short-term speculations are in full swing. That’s nothing new, of course, although it’s a safe bet that the usual suspects will be arriving in larger doses. Hedge funds will be having a field day, and making noisy signals for everyone else.