Big week. Bottom line: the Fed has an inflation problem, and markets are beginning to adjust – beginning – to how high and tight the Fed may have to pitch. Mortgage rates have held 6 percent, but barely, and probably temporarily.
Bonds ignored the terror alert in New York, ignored the bird flu flap, but did react to economic data, for the most part a lot of pointless lurching at post-Katrina garble. Last Monday, the purchasing managers’ manufacturing index for September soared to 59.4 from 52 in August, and the bond market fell apart in an instant. Bonds revived the next morning on news that the manager’s service-sector index had crashed to 53.3 post-Katrina from 65 in August.
The durable and damaging residual from the purchasing managers’ whipsaw: the prices-paid component of the surveys went off-chart in September: roughly 80 percent of purchasing managers paid higher prices for everything, not just energy products.
Friday morning’s coulda-been-worse September job report blew up bonds until traders realized the data didn’t include all the Katrina job losses. However, strong revisions in July and August jobs confirmed that the pre-Katrina economy was much stronger than thought, largely unharmed by energy prices and the Fed.
To understand inflation, make friends with somebody old. No one under 45 has a business memory of an energy-driven inflation episode. The central error that kids are making today is to believe that rising prices will slow the economy. The lesson of the ’70s: early-stage inflation stimulates the economy. Widely rising prices make the economy run hot – until the Fed removes the money necessary to pay them.
The Fed probably has a long way to go from today’s 3.75 percent to pre-empt inflation; on the low side of proper estimates, 4.5 percent by Fed Chairman Alan Greenspan’s last meeting on Jan. 31. The crucial 2s-to-10s Treasury spread is still within .2 percent, indicating that the market expects/hopes that the Fed will be tough enough, soon enough.
Markets also ignored disarray in the Bush administration. Your average trader holds all politicians in low esteem, and it takes a lot of disarray to get the attention of the bond market.
The Bushies are gettin’ close. Last Tuesday, the president was asked about a nominee to replace Greenspan. Bush answered, “I, frankly, hadn’t seen any, personally hadn’t seen any names yet.”
Some White House yahoo on background then offered that they were broadening the search for a new Federal Reserve chairman, hunting for someone who shared the administration’s economic philosophy, and who had personal rapport with Bush.
Capable Supreme Court Justices are important to the well-being of the republic, but mistakes are tolerable. Most Americans seem to think that choosing a new justice is like picking a new parent; one who will separate right from wrong, send one party to bed without supper, and pat the other on the head. Not so: there are nine co-equals heavily confined by precedent, and by each other, most gaining wisdom from the job.
The Fed chairman is more equal than the other 11 governors. He alone is the public face of confidence in the global financial system. Precedent is more often misleading than useful, as the one constant of money and markets is change.
The chairman must possess one skill above all others: he must be able to second-guess himself constantly and accurately. He must question everything from the speech he made over a week ago to his deepest assumptions about how the world works. If a gap opens between the chairman’s world view and the world as it actually is, then the nation and world will be punished. Often, severely.
Accurate world view has not been a Bush administration strength, but they have to get this one right. They just have to.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at email@example.com.
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