A. BOND MARKETS FIZZLE AS RATES SIZZLE
Though the yield on 10-year Treasury bonds reached a 52-week high last week, a more important issue is that the bull bond market that began in 1981, may be dead. Many believe the 45-year low for the noted bonds reached 3.11% on June 13th may not be seen again for decades. It appears the frenzy to own bonds probably went to far this past June. However, the most recent run-up in rates can be attributed to the Federal Reserve who a few weeks ago lowered the discount rate to only a quarter of a point when a half point was expected, and has commented that the economy may soon be growing over 4% ebbing the fear of deflation. These comments, together with significant borrowing needed by the Federal Government, caused 10 and 30-year Treasuries to decline around 10% and 15% in July, respectively, as 10-year rates surged to 4.6% last week. The 6-week increase in the 10-year Treasuries of 1.5%, or 47.9%, is astonishing. Though the bond decline may seem temperate compared to the dot com pop, bonds have actually lost more in a 3-month period than anytime since 1927. The last time rates surged like this, the effects rendered serious financial difficulties in some hedge funds as well as some major companies. Should similiar incidents reoccur, it could impose considerably more downward pressure.
Despite the rise in rates, stock indices have actually held up well, only slightly off from yearly highs. Overall, second quarter earnnings matched rather optimistic expectations. However, due to the lack of strong upside surprises, stocks have been unable to mount additional momentum so far. With rates higher, the dollar has also strengthened. Unfortunately, this makes U.S. goods less affordable abroad, which in effect may lower corporate earnings thus causing even greater U.S. trade deficits. Furthermore, if rates continue to rise, it could increase corporate costs decreasing the liklihood of a strong economic recovery. Consumers, the engine that has kept the economy in gear, is also likely to loose power. On the positive side, the U.S. financial markets may be more attractive to foreign money due to higher yields, especially when adjusted for currency fluctuations.
Adding to the already merky waters, important indicators released last week did not provide a clear direction for the economy. Despite positive signs in GDP growth of over 2.5% for the last quarter and a slight reduction in the unemployment rate, payrolls shrank by 44,000 last month with a loss of 486,000 jobs since the year began. Even worse, over 1 million jobs have been lost since the recession technically ended in November, 2001, and manufacturing employment is down 2.7 million jobs in just 2 years. Contrary to past recoveries, job growth is not ensuing. Moreover, employment sectors that are improving, (e.g. the service industry), have compensation levels that are lower than industries such as manufacturing and technology. Automation is creating a much more efficient work force here in the U.S., however off shore manufacturing is providing lower priced goods that, although good for consumers, is eliminating an increasing number of jobs. Many economists expect these dynamics to keep economic growth modest, which in turn, should keep interest rates from surging much higher. Top
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