interesting post.
here's a related article on direction of interest rates. i'd be most interested in your (or anyone's) reaction to it.
regards
10:10 ET ******
Interest Rates : Everyone understands that the direction of Fed policy is now a critical factor for the market. But understanding the interest rate environment is a more difficult task, and we are currently seeing many contradictory signals. First, there are the economists -- they almost unanimously expect the Fed to tighten several more times. Yet this unanimity should not be accepted as a clear sign that rates are headed higher; economists are notorious hindsight indicators. They always expect rates to head higher at the peak and lower at the trough. They never predict the inflection point in policy. So let's throw out that indicator. Second, there are the brokerage firms' various ratings moves which are related to the interest rate/economic cycle. Today, Morgan Stanley Dean Witter downgraded steel (ROU, IST, CMC) and banking (C, BAC) stocks due to expectations of an economic slowdown. This is actually a confusing call, as steel might get hurt by a slowing economy, but bank stocks typically turn when interest rates peak. And a slowing economy would imply that we are near that interest rate peak. Also today, Goldman Sachs downgraded two gold stocks (BMG, KGC). Despite all of the inflation fears running through the markets and the Federal Reserve, gold prices have certainly not reflected any inflation scare, and the Goldman downgrade is indicative of this complacency. Finally and most importantly, market indications are telling a more mixed story about rates. In addition to gold price weakness, we also see an inverted yield curve from the funds rate out to 10-year yields. No market indicator has a perfect track record in forecasting economic turning points, but the yield curve has been one of the best, hence its addition to the Leading Economic Indicators index a few years back. Inversion from the funds rate to 10-years has typically been followed by a marked economic slowdown. If the Fed were to raise rates another 100 bp, much less 200 bp, the yield curve inversion would be so extreme as to hint at future recession. Similarly, real short term rates (interest rates less the inflation rate) are already at a very high 4.5%, and boosting them to 5.5% or 6.5% would run the risk of inviting recession. In short, while economists and brokerage firms are offering mixed signals on rates, market indicators are hinting that rates aren't headed much higher -- recent declines in retail sales and home sales might be another indication that the market indicators are right. They usually are. - Greg Jones, Briefing.com
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