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How the Bond Markets React 04.25.05
Tightening for the Sake of Tightening
There is little left to do or so it seems from the Federal Reserve Board's point of view. There is a clear indication that inflation, sometimes referred to as pricing power is present in the marketplace. According to last weeks Producer Price Index, a gauge of how raw materials are priced into pipeline while the Consumer Price Index reflects prices delivered to the consumer, inflation is definitely here. Both indexes were up last week, and even excluding food and energy - too volatile - left Greenspan and co. with little choice but to continue down the path they have chosen.
The Open Market Committee would like to see a mild inflationary scenario but fears that many of the problems built into the marketplace will take firmer hold, the Fed is still attempting to talk inflation into some sort of control. The Fed meets again on May 3rd. Fed-funds futures, a predictive tool that helps determine how high the rates might go during a given period, points towards a 4% rate by year's end. It is currently at 2.75%.
Underlying question about economic strength and more importantly, consumer enthusiasm for the higher priced goods, the widening trade deficits, the seemingly intractable federal spending, and growing belief that inflation could suddenly accelerate have persisted leaving the Fed with little choice.
Calls for the revival of the 30-year long bond have been met with resistance even as the yields have risen. Falling prices, the opposite of rising yields suggest that inflation will eat away long term yields forcing investors into short term positions. This usually indicates that long term investing in fixed income securities will not beat inflation.
In other bond news (excerpted from the BlueMoney Report dated 04.25.05) -
The bond market may be the best indicator of where this market is headed. Alan Greenspan aside, the tightening in measured pace will continue largely because the Fed may be flummoxed by the continued credit party everyone seems to be having and simply can't think of another way to tighten the tap. The bond market is seeing those actions and grimacing.
Corporate yields have started to rise which means prices for said offerings have begun to fall. Add in the slow down of issues being offered and some distance is now being placed on the curve that compares corporate bonds to Treasury offerings with similar maturities. Tight yield curves tend to exist when the money supply is flowing freely because of cheap rates. Greenspan's conundrum several months back, his open worry over this very curve, is now in full correction. As the yields begin to spread away from each other, an effect of credit tightening, the economy slows down for a breather. On a side note, the risk of those offerings has increased with the yield pushing some otherwise solid companies well toward junk status.
Popular wisdom suggests that equities cannot hold up if the bond market goes into a funk. With the days of easy money quickly becoming a diminishing speck in the rear view mirror, equities will feel the hot breath of a short term bear.
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