THE ECONOMY:
Factory Orders Surprise to the Upside.
Just when the economic data was scaring most deeper into cover to hide from a soft patch, the late March data and the April data are starting to show positive signs. Construction data released Monday was big once more. The ISM equated to 3.8% GDP growth; hard to get too upset about that. Then Tuesday factory orders post a gain when they were expected to fall 1.2%. Is this something to change the economic character?
Despite the gain, probably not. Non-defense capital goods orders less aircraft fell 4% on top of a 2.1% drop in February. After the first of the year when the tax incentives started expiring, so did investment by business. That does nothing to help rectify the problem of demand outstripping supply during this recovery/expansion. That is what gave rise to the inflation we are seeing now. Yes consumer demand can fade and that would help bridge the gap, but if capital investment is fading as well, it is not going to catch up and get ahead of demand. To us this is a bad number just for that reason.
Want more? Nondurable orders (half of all factory orders) were up 2.8% after falling 1% in February (revised lower from -0.2%; hate those downside revisions as they show the real trend forming). These are orders on the 'demand' side of the economy, the part that is sparking the inflation.
Orders indicate continued inflationary pressures, and that keeps the Fed in the game.
Now you will rarely, rarely, rarely hear us bemoan prosperity. Prosperity is what we are all about. We want you to make a ton of money and go out and be the good American consumer you are. The problem is demand is still stronger than supply and supply is ebbing without having closed the gap on demand. That means more modest inflationary pressures that we have seen. Not huge, not stagflation, but the kind that the Fed is worrying about, and the Fed is in control of the game right now.
Now you can see how all of this is linked together: factory orders are up and that is good. Yet with the Fed in the game and tilting against inflation, that keeps the Fed active. An active Fed typically means the economy slows because the Fed goes too far. That weakens the market as we have seen for the past year since the Fed said it was going to start raising interest rates. The Fed may have all the good and benign intentions on earth. Indeed, many financial pundits commented that Greenspan was very aware that the Fed often goes one step too far (just one?). Be that as it may, the Fed cannot help itself. Greenspan is now dealing with one side of the FOMC that says hike faster and another that says stop hiking. When Greenspan is gone who will win? That is a sobering thought.
Challenger layoffs fall to a 4.5 year low.
At 57.8K it still seems high, but compared to the March 86.3K it was a solid 44% reduction. Compared to the past few years with 100K+ per month layoffs it seems like springtime. It isn't, but the numbers try to make it feel that way. After several years of layoffs and outsourcing there may not be much more to cut. Not entirely true; we continue to see big companies announcing new layoffs this year, and there are still plans to continue outsourcing. That is very hard on us here in the US right now. Eventually it leads to a higher standard of living as the next wave of technologies and industries spark the cutting edge jobs - - IF we continue to invest in the US and don't go into hibernation. Companies have been investing their profits, but as the factory orders and Q1 GDP show, the amount of investment has dropped off since the first of the year.
It is always good sign to see layoffs falling; it just is not the greatest sign. After all, jobs are a lagging indicator, and many of the more leading have shown a slowdown that we saw in the first of the year. Thus even if layoffs are slowing they could continue if this slow patch turns into a real slowdown compliments of high energy prices and a Fed that is definitely finding itself in a hard place.
The Fed's Gaffe (just one?).
Fed raises rates, keeps measured pace alive, implies energy costs are passing to consumer, and, oh yea, notes inflation is still well-contained.
The Fed raised rates to 3% and kept its statement pretty much the same. The same, that is, after it reinserted the statement that long term inflation expectations were well contained. That was omitted from the early press release and that added to the slightly more hawkish tone of the announcement. The fact that the pace will remain measured is in itself something of a surprise; the Fed was ready to take it out after last month's change. The Fed really does move slowly.
The market was perturbed by the Fed keeping to its measured pace. On the one hand that means there won't be any 50 BP hikes sailing in from right field and whacking the market and economy, at least not yet. Still, it also virtually guarantees another 25 BP rate hike at the next meeting. That is not such bad news; after all the Fed Funds Futures contract had priced in 75BP more in hikes (25 at a time), and Tuesday was simply the first of the group. Of course come June investors are going to be watching closely to see if 'measured' is taken out. Things will get kind of itchy if 'measured' stays in the next statement because as we discussed Monday, 'measured' has to come out before the Fed is going to stop its hikes. It is hard to not raise rates if you say you are going to do it even if it is at a measured pace. With just one more hike priced in after the next meeting there will be a lot of pacing with respect to that next and hopefully final hike to 3.5%.
That remains to be seen. What is clear is that the Fed is going to keep raising rates for now because it still sees inflation as a problem. Even with the reinsertion of the language that long term inflation expectations are well contained the Fed is still going to raise rates again. As noted, it also took out the sentence about rising energy costs not passing through to the consumer. We don't know if it will stick that back in tomorrow, but if it does not it implies that the Fed sees the costs making it into the consumer's wallet. Despite energy being a tax on business and the consumer, the Fed tends to view rising consumer prices as a result of energy costs as inflation, and it tends to fight inflation the only way it can, i.e. with the interest rate club. Thus more rate hikes.
Now it is not really true that the Fed has only one weapon. Money supply is another, and some would argue it is more important than rates. After all, rates can be extremely low as they were in 2001, but if the Fed does not pump up the money supply it is like having a sale without having any of the goods on hand. You would buy at that price but gee, there is nothing to buy. Until the Fed pumped up the money supply to a level that was synergistic with the rates, the economy was stuck. Money can be cheap, but there has to be money or else it does not matter what rates are.
Right now the Fed has sucked away the money from the economy once more. The Fed Funds rate may be 3%, but its policy is much tighter. Rates have risen 200% and at the same time money supply growth has dropped to 2% from 10%. While it is not draining the pool it is roping off parts of it. Some are saying this is very much like 2000 when rate hikes were not stopping the economy as fast as it wanted. The Fed simply pulled the plug on the money supply and called back all of the loans for Y2K. That money had to be taken out of the stock market (that is where it went since there was no liquidity problem as some thought there would be). When that happened the market bucked and started the collapse. The economy followed.
As money leads the economy by about 12 months, the Fed is in the same game as with rate hikes: the impact will be felt well down the road and the Fed has to guess how much brake to apply and see how it comes out on the other side. Very inaccurate method to use to micromanage the economy. Educated guessing is the best label we can give it. It reminds us of dropping water balloons out of a building and seeing what poor sap wanders by and gets hit, if anyone. From the time the balloon is dropped to the time it hits a lot can happen: the wind can blow it off course, the target can move, another can take its place, the cops can show up and throw you in jail. The result is pretty much the same; in the end the balloon splats on something. Kind of like the economy did in 2000.
In sum, the Fed has locked itself into a 25 BP hike at the next meeting as it retained the 'measured pace' language. It also emphasized inflation a bit more by removing the phrase regarding energy cost pass through. It is more concerned with inflation than with any slowdown. It still sees the current Fed Funds rate as fostering expansion. The Fed may be very aware of its sins of the past, but for now it stands ready to continue raising rates. It may get it right this time, but history is not on its side. Thus as long as the Fed is hiking the market remains scared. Just look at the past 14 months from when the Fed started talking about raising rates to actually doing so: the market has moved basically sideways. The only relief it enjoyed was the end of 2004 when it looked as if the Fed may have been finished and oil was trying to roll over. Neither came true and now the market has given back what it took in the late 2004 rally, and it threatens to give more back. |
