Since this spring I have been pointing out that the
Federal Reserve was engaged in a classic form of
Greenspan fine-tuning, to wit, gently but persistently
raising interest rates and curbing basic monetary liquidity
with an eye to slowing down the economy enough to produce
a flattening of or deceleration of inflation pressure.
The Fed also desires to raise short rates enough to restore
a better balance between savings on the one hand, and
consumption/investment on the other.
A slowing of economic growth was a "gimme" since it had
already began decelerating even before the Fed first swung
in to action in mid-2004.
The Fed, as discussed in past months, has not had any real
luck with the rest of its plan. Inflation pressure has
accelerated and broadened, and there has not been enough
of an incentive created to get folks to boost savings.
When I extend present trends on the relevant economic
charts, I see we are headed for trouble by the end of the
second quarter, 2006. By then the US would be at effective
capacity, inflation pressures would have intensified
further, and short rates would have reached levels high
enough to curb credit demand and produce an economic
retrenchment. This scenario would be entirely
consistent with development of cyclical bear markets in
both stocks and bonds prior to yearend, 2005.
And, as we have seen in recent weeks, investors are
already beginning to shade the market multiple and to
push up yields.
I have also argued that the Fed should be moving in
50 basis point increments with Fed Funds, but that appears
to be neither here nor there as things now stand.
I am standing back from the bearish scenario because I
suspect fuel prices have risen to levels sufficient to
induce rising conservation and a rethinking of household
and business budgets. My best guess is that should
such eventuate, fuel prices would roll over and come
down substantially from present levels. This adjustment
would temporarily pressure economic momentum but might
allow the US to escape far more serious trouble next
year. I also need to direct attention once more to the
continuing very low growth of productive capacity, which
in turn puts more of the weight on demand suppression,
if the US is to escape a nasty time.
Short term, I am going to be focusing on commodities
prices, the leading inflation precursor, and on personal
consumption factors, for these are the two spots where
it can best be determined if the softer landing can be
achieved. At this stage, a pick up in the growth of
productive capacity can only be devoutly wished for.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 40 years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!