Fear of A Strong
Economy, Again
By Duru
August 7,
2005
The quick
trigger fingers were on open display after Friday's strong jobs report spooked
the bond market. The conventional wisdom
I am reading is that the jobs report sounds inflationary, and the strength it
shows will convince the Fed to keep raising rates well beyond the window most
folks were hoping for. Now, why the
surprise? I still cannot
understand. I have never bought into the
growing hopes folks have had for an imminent retirement to the rate-hiking
campaign. In fact, a few months ago, I clearly pointed out that the Fed
has gotten dead-serious about fighting inflation. It is quite ironic that the Fed has nailed
things right on the head this time: the economy is quite strong and doing
well. Even the dollar of late has been
handing out a beat-down to the Euro. Given
that the economy can absorb much higher interest rates than we have now. Look how well the economy has absorbed ever
high oil prices and the prices of many other commodities. Indeed, the continued strength in the housing
market given the continued stubbornness of long-term yields compels
the Fed to keep hiking those short-term rates up and up. A smart player will forget about trying to
predict the end of this campaign and instead focus on the market's reaction to
events as they unravel.
The jump in
long-term rates (the 10-year bond leapt a huge 7 basis points) means that we
have gotten that much closer to the supposed day of reckoning in the housing
market. Lost in the buzz about the dire
consequences is that these rates are still below the levels we saw right
before the market bottomed for this year.
These rates are not even close to those seen at the peak of bond yields
in 2004. Certainly, there is a short-term
trend up in rates, but longer-term,
you would be hard-pressed to make a convincing case for an up-trend. (I strongly encourage you to take a look at
the charts by clicking the links for the Yahoo charts. If I get time later, I will post my own.) Wachovia
threw its hat into the bearish ring by issuing a downgrade to one of the top
homebuilders, Toll Brothers (TOL). Part
of their downgrade from market outperform to market perform (oh the horror to
only perform as good as the rest of the market!) referred to some potential
weakness in
Now, do not
worry. I am not suddenly adopting the
hubris that so many still have in the housing sector. Note well that housing has become an
extremely important component of
In the
meantime, I actually remain relatively bullish on the market as a whole. We should expect a sharp correction in
reaction to Friday's news and to any
hawkish comments from Greenie next week, but I suspect that after the market
realizes that nothing has fundamentally changed, the rally for 2005 will pick
up again. The last time I noted the
market's fears over a strong economy in April of 2004, the market promptly fell
steeply for about a month before bouncing back just as sharply. After a continued campaign of interest rate
hikes, we are now 6% higher on the S&P.
This run is all the proof we need that economic activity remains robust
all things considered. But make no
mistake about it, there is not likely a whole lot of breathing room left at
these heights. So, as always, be careful out there!