These days, risk is feeling the pressure. Traditionally, aiming for higher returns through increased risk has been a tried-and-true method for elevating profits. However, this approach can backfire during periods of uncertainty, as evidenced by this year’s varied performances across the equity markets.
While China and the United States are worlds apart, Treasury Secretary John Snow seems intent on drawing parallels. During his recent visit to China, he commented on the rapid consumer spending there, noting that purchases of televisions, cars, and other goods are on the rise. He expressed concern over the need to bolster China’s consumer credit system to facilitate further economic development. Snow pointed out that the country’s remarkably high savings rate is not being utilized as effectively as it could be.
The current situation is familiar: overall inflation is on the rise, while the core inflation rate (excluding food and energy) remains stable. This leads investors to grapple with an ongoing dilemma: which measure of inflation can be trusted?
This morning’s Labor Department report on import and export prices is poised to reignite discussions about whether rising energy costs represent more than a temporary inflation threat. While economists debate long-term implications, the current situation offers a clearer picture.
Statisticians often remark that if you manipulate data long enough, it’ll reveal whatever you want, which cleverly implies that one can prove nearly anything by twisting the numbers. However, data manipulation can go both ways; it’s just as possible that the data may not be entirely reliable before the analysis begins.
There is “no doubt” that the Federal Reserve will increase its benchmark short-term interest rate to 4.0% at the upcoming FOMC meeting on November 1, up from the current 3.75%, according to Asha Bangalore, an economist at Northern Trust. The market agrees, as indicated by the November 2005 Fed funds futures contract, which is predicting a rise to 4.0% by the time of the meeting. Furthermore, the futures market hints at even higher rates ahead, according to the current pricing of the March 2006 contract.
While observing the shape of the yield curve doesn’t guarantee future predictions, it is wise for investors to keep an eye on the changing dynamics between interest rates associated with various Treasury maturities. Currently, on this Columbus Day, the concern is whether a flattening yield curve will transition into an inverted one, where short-term rates surpass long-term rates. Notably, the 10-year Treasury yield currently offers just an 18-basis-point premium over its two-year equivalent, as per Bloomberg. Should the 10-year yield ever dip below that of the two-year yield, it could signal troubling times for the economy; historically, each of the last six recessions has been preceded by such an inversion. A recent primer on yield curves, titled “The Yield Curve as a Leading Indicator” by economist Arturo Estrella of the New York Federal Reserve Bank, discusses this phenomenon in depth. This insightful research piece utilizes a question-and-answer format and includes a comprehensive bibliography for those looking to explore more. While it won’t provide absolute certainty about the future, it does illuminate the role of yield curves as a forecasting tool. Considering the current climate, this fresh perspective on the topic is highly relevant, and CS has included the paper in the Research Room.
The bond market has yet to respond to the latest discussions around inflation, but both the dollar and gold are reacting to this dialogue.
When inflation eventually emerges, history shows that the situation is seldom unclear. For instance, during the 1970s, there was widespread agreement on inflation’s status as a legitimate danger. However, in the 21st century, such clarity may be a luxury we can’t afford. Instead, we may face a barrage of conflicting forecasts and significant uncertainty surrounding economic indicators.
The latest economic reports send mixed signals. Just two days after the Institute for Supply Management announced a stronger-than-expected manufacturing activity for September, ISM published its September survey for the services sector, which casts doubt on the previous optimism. The Non-Manufacturing Business Activity Index fell to 53.3 from August’s 65, indicating a slower growth rate. While 53.3 still represents growth, it marks the lowest reading since April 2003.
