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Strategies & Market Trends : MDA - Market Direction Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Haim R. Branisteanu who wrote (36021)	12/26/1999 9:05:00 AM
From: Crimson Ghost	Respond to of 99985

Morgan Stanley economist expects aggressive Fed tightening next year. From Healing to Fire? Stephen Roach (New York) As the millennium draws to a close, there can be no mistaking the extraordinary recovery in the world economy in the aftermath of the crisis-induced recession of 1998. With the notable exception of Japan, Asia has bounced back with a vengeance. Europe is ending the year on an increasingly solid note, with a long lagging German economy finally kicking in. Nor are there signs of any let-up in the great American growth saga, as yet another slowdown bet is getting blown away by a powerful upsurge that seems destined to spill over into 2000. US vigor is also driving the remainder of the NAFTA bloc to the upside, with Canada and Mexico experiencing significant upturns that should have beneficial impacts throughout Latin America. Even Eastern and Central Europe seem largely on the mend, supported by improved conditions in Russia, Poland, and the Czech Republic. Up until now, financial markets have basked in the warm glow of global healing. While interest rates have bounced back from the crisis-depressed lows of late 1998, equity markets have enjoyed unfailing support from the surprising vigor of output and earnings growth. To be sure, this has led to extraordinary valuation strains on European and US equity markets, where our models suggest that broad averages in both regions are at least 40% above "fair value." But perceptions of a new era abound. That has not only challenged the macro rules that have long governed once sacred economic relationships -- such as the timeworn linkage between growth and inflation -- but it has also questioned the relevance of the connection between bond and equity markets. New paradigm or not, wealth creation in financial markets has played an exceedingly powerful role in supporting the newfound vigor in the global economy. A key challenge for 2000 is whether this relationship will endure. The major risk, in my view, is that the relationship between financial markets and their economic underpinnings could be turned inside out. That could occur if the excesses of wealth-driven economies were to sow the seeds of a sharp correction in financial markets. How could this possibly happen? The answer, in my view, lies in the timeworn tradeoff between the structural and cyclical forces that shape economic and financial market out-comes. In our version of the new macro, the laws of sup-ply and demand have not been repealed. To the contrary, I would stress that under our baseline scenario of at least 4% world GDP growth over the next couple of years, the gap between aggregate supply and demand that was opened up in the crisis-induced global recession of 1998 should be virtually eliminated by the end of 2001. This drives our prognosis of a modest upturn in global inflation from its cyclical low of 2.4% in 1999 to 3.2% in 2001, sufficient to outweigh the ongoing structural forces of a technology-led disinflation. In the increasingly vigorous global growth outcome we envision, the balance of risks will shift from the structural to the cyclical. For financial markets, that changes everything. Most importantly, it puts the onus back on central banks as the ultimate arbiters of the macro climate. Here?s where the extremes of the new paradigm bet ask for trouble. Investors are convinced that inflation and economic growth have become permanently de-linked. We haven?t bought that view -- nor have central banks. While the authorities may have raised their tolerance of an economic speed limit, they still believe that such a threshold exists. Under that key presumption, there can be no mistaking the excesses of America?s ongoing growth vigor -- four years of 4%-plus growth violates even the most optimistic estimates of the US economy?s inflation-stable growth rate. The Federal Reserve, under those circumstances, has little choice other than to continue its recent tightening campaign, going well beyond the post-crisis normalization drill that was executed in 1999. Hence, we look for an additional 75 bps of Fed tightening in 2000, a hike that we think will be matched by the ECB and the Bank of England. With most of the world?s major central banks in a tightening mode, and with global growth tipping dramatically to the upside, it?s hard to look for any meaningful relief in global bond markets. We continue to believe that long rates are most at risk in the United States -- not just be-cause of the inflationary potential of fully employed labor markets but also because of the real interest rate pressures stemming from the external financing requirements of America?s record current account deficit. On that count, the sharp 25 bp back-up in real long-term interest rates that has occurred over the past five months (as measured in the 10-year TIPS market) bears special note. For the first time since the current bond market correction began a year ago, pressures are coming more from real rates than from inflationary expectations. Consequently, if US inflation risks tip to the upside, as we suspect, the back-up in nominal bond yields could be all the more acute. With the risks to bond yields skewed to the upside, pressure for a correction can only build on over-valued equity markets. And depending on the duration of the coming correction, the feedback effects into wealth-dependent real economies could be decisive in shaping the global macro climate in 2000. It is in that sense that global healing may well beget the fierier endgame that I have long feared. While the world economy appears to be on the cusp of two outstanding years, ever-exuberant financial markets may become increasingly intolerant of all this good news.

To: Haim R. Branisteanu who wrote (36021)	12/26/1999 9:57:00 AM
From: John Madarasz	Read Replies (1) \| Respond to of 99985

Economic Week in Review: December 20-24, 1999 Citing its interest in ensuring smooth sailing during the Year 2000 computer systems change, the Federal Reserve Board's Open Market Committee held short-term interest rates steady this week. But Fed policymakers also issued a caution about inflationary signs--in particular, that demand for goods and services continues to grow at a faster pace than potential supply. Bond yields, which move in the opposite direction from prices, reached their highest levels in two years after the Fed's statement on Tuesday. As of the close of trading Thursday, the yield of the 30-year U.S. Treasury bond was 6.48%, up 10 basis points for the holiday-shortened week. Gains in technology stocks propelled stock markets into record territory, and the S&P 500 Index climbed 2.6% for the week. The U.S. economy expanded at an inflation-adjusted annual rate of 5.7% from July through September, the Commerce Department reported Wednesday in its final estimate of third-quarter gross domestic product (GDP). The estimate of growth in the economy's total output of goods and services was up from the previous figure of 5.5%. A buildup of inventories primarily accounted for the sharp rise over the second quarter's 1.9% growth pace, the Commerce Department said. The third- quarter expansion was much faster than the 3% rate that the Fed considers sustainable, fueling speculation that the Fed will boost short-term interest rates in early February. Yet, the GDP price deflator--the broadest measure of inflation--estimated that prices rose during the third quarter at an annual rate of just 1.1%. Personal income rose 0.4% during November, while personal spending rose 0.5%, the Commerce Department said Thursday. Although the increase in personal income was the slowest since August, it was higher than expected. The spending figure, which was in line with expectations, is closely watched because consumers fuel two-thirds of the U.S. economy through purchases of goods and services. Americans saved only 2.2% of their after-tax income during the month, down from 2.3% in October. Orders for durable goods--big-ticket items such as cars, airplanes, and washing machines that are expected to last three years or more-- reversed two monthly declines to rise 1.2% during November, the Commerce Department reported Thursday. A sharp increase in orders for electronic and electrical equipment accounted for much of the change. The Labor Department said the number of people filing new claims for unemployment compensation increased to 281,000 during the week ended December 18 from a revised 267,000 the preceding week. The four-week moving average, a more reliable indicator of employment trends, rose to 283,750 from a revised 282,250 the previous week. Few economic reports are due the final week of 1999. They include an estimate of existing-home sales and a survey of consumer confidence (both on Tuesday) and the index of leading economic indicators (Wednesday). Markets will close at 1 p.m. Eastern time, Friday, December 31. Summary of Major Economic Reports: December 20-24, 1999 ----------------------------------------------------------------------- \|Date Report Actual Expected 30-Year S&P 500 \| \| Value Value Bond Yield Index \| \|---------------------------------------------------------------------\| \|December 20 +5 bp -0.2% \| \|---------------------------------------------------------------------\| \|December 21 FOMC meeting +2 bp +1.1% \| \| ends with \| \| no change \| \| in short-term \| \| interest \| \| rates. \| \|---------------------------------------------------------------------\| \|December 22 Real Gross +5.7% +5.5% No change +0.2 \| \| Domestic \| \| Product (Q3, \| \| annual rate) \| \|---------------------------------------------------------------------\| \|December 23 Personal +0.4% +0.2% \| \| Income (November) \| \|---------------------------------------------------------------------\| \| Personal +0.5% +0.5% \| \| Spending \| \| (November) \| \|---------------------------------------------------------------------\| \| Durable-Goods +1.2% +1.1% \| \| Orders (November) \| \|---------------------------------------------------------------------\| \| Initial Jobless 281,000 280,000 +3 bp +1.6% \| \| Claims (12/18) \| \|---------------------------------------------------------------------\| \|December 24 Christmas -- -- \| \| Eve--U.S. \| \| financial \| \| markets closed. \| \|---------------------------------------------------------------------\| \| Weekly +10 bp +2.6% \| \| Change \| ----------------------------------------------------------------------- bp = basis points. The most recent Economic Week in Review can be found below. The report is best viewed by setting your browser to a mono-spaced font such as 10-point Courier. (AOL Users: Because the AOL default browser's font cannot be set, the report's table may be difficult to read. For best viewing, click on the Economic Week in Review from Vanguard's homepage at vanguard.com )