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Commentary
Limited Returns
In spite of contained yields on the long-end of the curve, because of the Fed’s consistent pressure on short-term rates throughout 2005, the U.S. treasury market (as measured by the Lehman Brothers Global Treasury Index) generated a total rate of return of only 2.79% in 2005. This gain ranked as number 27 in a field of 32 industrialized-country treasury markets surveyed. It also represented the lowest rate of return attained since 1999. The highest local currency-adjusted returns occurred in Mexico, which generated a total return during 2005 of 15.37%. Only three countries (Singapore, South Korea, and Hong Kong) generated negative rates of return.
Minute by Minute
Minutes from the December 13 FOMC meeting indicated that the Fed believes that the funds rate is no longer at a level that would stimulate growth. The Fed abandoned its characterization of its policy as being “accommodative” and specified that “some further measured policy firming is likely needed.” Previously, the Fed had stated that it will likely continue to increase rates “at a pace that is likely to be measured.” Perhaps the retained mention of “measured” was meant to signal the remoteness of a near-term tightening beyond 25 basis points. Indeed, the minutes mentioned that “the number of additional [rate increases] required would probably not be large.” Further, the Fed seems to acknowledge that the economic outlook is becoming “considerately less certain” and “data dependent.” Key data points will continue to be the employment situation, productivity, the personal consumption expenditures inflation index, and capacity utilization.
There are several variables in favor of continued rate increases, including rebounding industrial production and continued strong consumer sentiment (outside of the auto sector). Capital spending grew at a rate of 11% throughout 2005. Moreover, S&P 500 companies bolstered capital spending by 24% year-over-year.
Nonetheless, there remain numerous reasons for the Fed to relax the reins, including:
- Modest increases in unit labor costs. The Labor Department’s employment cost index has been rising at 3.0% annually, representing the smallest rate of increase in over five years.
- The 1.8% annualized personal consumption price index for November is considered to be within the Fed’s realm of acceptability.
- The employment picture may be slowing. In the wake of a job creation rate of only 50% of expectation for December, there are growing questions about the sustainability of the 40,000 monthly job gains that have been ascribed (directly and indirectly) to the housing sector.
- The complexion of the FOMC is changing. It remains to be seen if the hawkish monetary stances of departing members Richard Fisher, Edward Gramlich, Micheal Moskow, Anthnoy Santomero, and Gary Stern will be perpetuated by new members: Jack Guynn, Jeffrey Lacker, Sandra Pianalto, and Janet Yellen.
The post-Greenspan era at the Fed may prove more difficult to project. The What Counts composite forecast of select economists shows an anticipated funds rate of 4.75% from mid-to-late 2006. This represents a decline of 12.5 basis points from last month’s estimates. Presently, the Fed funds futures market is pricing in a 99%+ chance of a 25 basis points hike at the January 31 meeting, with an approximately 50% chance of a similar hike at the March 28 meeting.
Housing Market and Consumer Credit – Feeling a Draft?
Signs of slowing momentum in the housing markets continue to surface. According to the National Association of Realtors, its index of pending home sales declined by 2.5% during November—the third consecutive monthly decline.
Over the past quarter, the consumer has appeared reluctant to take on new debt. Non-mortgage, individual consumer debt continued its unexpected decline during November. The .4% annualized decline came on the heels of October’s 4.7% drop. A slight increase in revolving debt was dwarfed by a sizeable reduction in auto loans and other term debt. November’s drop in consumer debt represents the first back-to-back rate of decline in consumer debt since mid-1992. It remains to be seen whether reduced consumer debt activity will lead to reduced consumer spending, a deceleration in the pace of import growth and, in turn, a sustained narrowing of the trade deficit.
Some Progress on the Ex-Im Front
Surging aircraft orders helped to narrow the November trade deficit, from $68.1 billion to $64.2 billion. Although the deficit level remains the third highest on record, this represented the first narrowing in eight months. In addition, for the first time in a year, thanks in part to a decline in the price of crude oil, import prices declined – by .2% during November. (Don’t hold your breath, however; as of this writing, the price of crude oil has rebounded above $65 due to geopolitical concerns.) With third-quarter returns in, the U.S. economy grew at an annualized rate of 3.6%. The GDP growth rate compared favorably with respective growth rates of Euro-issuing countries and Japan, of 1.6% and 2.9%, respectively.
Employment Watch
December’s employment situation report came in a bit softer than expected. While the reported increase of 108,000 workers was substantially below the expected 200,000 increase, the November payroll number was upwardly revised, from 215,000 to 305,000. Why the upward revision? It may be ascribed to the resumption of postal and other services in the New Orleans area.
The final employment tally is in for 2005. Average hourly wages increased by 3.1%—the highest level since 2002. Only 2.02 million jobs were created relative to 2.20 million in 2004; still, 2005’s record of job creation and .5% reduction in the unemployment rate was close to records established in the late 1990s.
Debt Ceiling Drama
As expected, political and economic reality will soon collide over the $8.18-billion statutory debt ceiling. If Congress does not soon address the Administration’s request to increase the debt issuance limitation, the ceiling will likely be reached by the third week of February. As a temporary measure, the U.S. Treasury will likely be forced to suspend issuance of State and Local Government Series securities, forcing a required Congressional increase in the ceiling by late-March. Any such increase would likely serve as a temporary measure, such that the debt-ceiling issue becomes spotlighted during the November election. During past debt-ceiling disputes, suspension of State and Local Government Series securities has often created intermediate-term yields to show stronger price performance relative to other sectors of the curve.
John Biestman is Director of Business Development at the Federal Home Loan Bank of Seattle.
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