RateWatch #422 Where the Economy May Be Going
August 28, 2004 by Dick Lepre
2nd Q GDP growth was revised downward to +2.8%. Expectation was +2.7%. This is a positive only to the extent that some feared uglier data. While 2.8% economic growth is not cause for excitement it is certainly in the range of acceptable. The GDP Chain Deflator - a very broad measure of inflation - was exactly at expectation at 3.2%. U Michigan Consumer Sentiment (predisposition to spend) was slightly lower than previous but not a market mover.
Personal Income and Spending are next Monday. The monthly BLS Employment Situation Report is next Friday. Because of its timing, this report will probably have as much political significance than economic significance. It is a precept of economic mythology that the President
has responsibility for job growth or loss. Mythology aside, expectation is +150,000 for this datum which always seems to surprise.
In speaking with several borrowers lately I have become aware of the fact that there are many folks out there who think that mortgage interest rates are rising and going to continue to do so.
There is no evidence that this is the case. The Fed is in a tightening (higher rates) mode but since they have started tightening bonds have rallied driving down Treasury yields and mortgage rates.
As I have preached for many years, Treasury yields and mortgage rates run in cycles best described by out friend, StoMaster. This technical analysis shows that we will be moving from
a bearish (lower Treasury prices and higher yields and rates) to a bullish cycle (higher prices and lower rates) in the 4th Q.
Put simply: there is no upward pressure on mortgage rates. There is no upward pressure because there is little inflation even with higher oil prices. There is little sign of anything in the near future (the next 18-24 months) that would rekindle inflation.
The primary reason is that the economy added an inordinate amount on the supply side in the 1990's. Companies were started and plants were built or, rather, overbuilt.
It is difficult to look at where we are and not face the question: isn't this where Japan was 15 years ago? Didn't they overbuild and then have a dozen or more years of recessing and deflation?
There are two reasons why the U.S. is not likely to go the same way as Japan:
1) Japan has always had a "top down" economy. The banking system caters to business. The assets of their banks were tied up in bad loans or equity investments in Japanese companies. When the bubble in real estate value and equities happened there, little was done to address the problem. Here, when we have problems we open them up for public viewing. We addressed the S&L crisis in the '80's. Greenspan allowed the equity bubble to burst starting in 1999. In the United States the banking system caters more to the masses and corporate accounting scandals are played out in the public forum.
Bank assets are not tied up in equities and banks have resisted the risky commercial loans that were responsible, to a significant extent, for the S&L crisis.
2) The American economy is driven by the American consumer. American consumers don't really worry about things. In the 4th Q of 2001 we had a gigantic national tragedy and the economy was in recession. Yet, it ended quickly. Some credit is due to the Fed's willingness to lower rates, some credit may be given to the administration and Congress for fiscal stimulus but
the vast majority of the credit goes to the American consumer who, after a few weeks in a funk, went right out and started spending again.
The issue of a bearish market for bonds would seem to imply that we are in for "tough times" for the economy. While we may have to learn to live with GDP growth close to 3% for a few years that is hardly a nightmare. We may be moving into a time of low rates, modest growth, low inflation and an unemployment rate around 5.5%. Is that so bad?
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