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Pastimes : Ask Mohan about the Market -- Ignore unavailable to you. Want to Upgrade?

To: Real Man who wrote (11973)	12/20/1997 3:56:00 PM
From: Tommaso	Read Replies (1) \| Respond to of 18056

If I said, or seemed to say, that low long-term interest rates could cause a recession, I certainly did not mean to do so. But it does appear that whenever short term rates are two percentage points above long term rates, conditions have arisen that almost guarantee a recession. The Federal reserve does have a lot of control over short term interest rates and by pushing them up to about 7.9% right now could surely cause a recession. Not that anyone imagines that they would do such a thing. They could do it, and in fact have pushed much harder than that at times in order to stop inflation. But merely by keeping things the same, the Fed could also cause a recession if long term rates keep dropping to the point that the ten-year bond is yielding less than 4%. Such a rate seems very unlikely right now but not impossible. With the stock market as inflated as it is, a guaranteed recession is not needed to bring a large decline. A flat yield curve, which we are very close to achieving (or seeing), suggests a growing perception that economic production will simply hold steady. Whether that happens or not is another question (I think some actual shrinkage is more likely). But current stock prices can be justified only on the belief that growth will continue at very high rates. Maybe what I mean to say is that right at this moment low long-term interest rates reflect a diminished desire to make long-term investments because of the growing uneasiness that such investments can pay off. Current interest rates, then, forecast (not cause) a no-growth period for the economy. When that forecast is widely accepted, it will be very hard on the stock market because it will be seen that the market has included as much as ten years' growth in its valuation. In any case, it's not just long-term rates that are at issue, it's the relation of long-term to short term rates. That relation seems to forecast a flat economy. And a flat economy means stock prices that drop to reflect diminished expectations. If these arguments seem circular it's because cause and effect in the economy are themselves circular--or cyclical. Nothing ever stops the way a symphony stops at the end or the way a mathematical proof reaches a conclusion. But for all the arguments see the article: ny.frb.org