After the testimony, market participants concluded that while Greenspan certainly set the stage for a rate hike, he gave no indication whatsoever about the timing of this hike. So what do we know now' That the Fed intends to raise rates when inflationary pressures are viewed to be a concern and that the employment situation is clearly growing.
It seems to me that we already knew this. It is hard to believe that market players truly believed that the Fed would leave the federal funds rate target at 1 percent forever. Certainly, an expanding economic environment coupled with price pressures and increased hiring is going to require that the Fed begin to tighten credit conditions and become less accommodative than they are now.
Greenspan's simple admission that the Fed would eventually raise the fed funds rate target impacted financial markets across the board.
STOCKS
Stock prices were hammered on Tuesday after Greenspan's banking testimony. The Nasdaq composite index posted the largest drop (-2.1 percent) followed by the Russell 2000 (-1.9 percent), the S&P 500
(-1.6 percent), the Wilshire 5000 (-1.5 percent) and the Dow Jones industrials (-1.2 percent). The possibility of a rate hike even with an unspecified timing element simply devastated market players despite the fact that it implied that the economy was expanding nicely and that corporate profits were likely to increase. The knee jerk reaction by equity investors was negative.
It is certainly possible that investors realized on Wednesday that small increases in interest rates wouldn't necessarily hurt businesses. After all, an expanding economic environment supports revenue and profit growth. Modest gains in interest rates are likely to have minimal impact on profits whereas rising domestic employment will generate sales and boost profits. Greenspan's testimony on Wednesday didn't seem to hurt market sentiment at all. In fact, the major indexes, except for the DJIA, were all higher on the day. The Russell 2000 posted the largest gain (1.3 percent) followed by the Nasdaq composite (0.9 percent), the Wilshire 5000 (0.6 percent) and the S&P 500 (0.5 percent); the DJIA was unchanged.
It is interesting to compare the market reaction to Greenspan's fuzzy comments (he never specified a date with his "rising rates" comment) to the market reaction following the release of the March employment report on April 2. Stock prices rose sharply on that day even though investors realized that sustained increases in nonfarm payrolls would generate rate hikes. Equity investors realized that higher revenues generated by consumer spending far outweighed the negative impact of small rate hikes.
BONDS
It was no surprise that the bond market reacted in a negative fashion to the Greenspan testimony. After all, he did mention the words rates and rise in the same sentence on Tuesday afternoon. Treasury yields increased sharply across the board.
Considering that Greenspan neglected to mention when the Fed actually intended to raise rates, it is surprising that yields rose so much. After all, rates had already jumped a few weeks before on the heels of the surprisingly robust March employment report. At that time, yields rose three times as sharply as they did this past week. The rate gains on employment day essentially corresponded to one 25 basis point rate hike. That is, yields generally rose as much as bond investors expected that the Fed would raise rates.
The April 21 increase in rates was almost gratuitous since one rate hike was already factored in after the employment report. In fact, rates have been on a rising trend since the employment report. Thus, more than one rate hike has already been factored in. Consider the difference in rates from April 1 and April 20 in the chart below. Bond investors have already factored in two hikes of 25 basis points each (or one 50 basis points rate hike). This certainly shows how the bond market leads the Fed, rather than the other way around.
CURRENCIES
The foreign exchange value of the dollar increased with the Greenspan testimony. Indeed, the dollar rose 1.3 percent relative to the euro and 0.3 percent relative to the yen. The dollar also increased on April 2 after the employment report: 1.9 percent against the euro and 0.8 percent against the yen.
Just like the rising interest rate trends in the Treasury market, the dollar has seen a rising trend in the foreign exchange market over the past few weeks. Thus, the total improvement in the dollar relative to the euro and the yen is larger than the sum of the April 2nd and April 20th gains.
GOLD PRICES
In the past year, gold prices have moved inversely with the dollar. That is, each time the foreign exchange value of the dollar fell relative to the euro, gold prices rose. Now that the dollar is rising against the euro, gold prices are falling. On Tuesday, after Greenspan's first congressional testimony of the week, gold prices fell 1.3 percent. This is comparable to the 1.1 percent drop posted on April 2 after the surprisingly robust employment report.
Markets at a Glance
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
The Economy
PPI jumps again
The producer price index jumped 0.5 percent in March after increasing a more modest 0.1 percent in February and a larger 0.6 percent hike in January. Energy prices rose a moderate 0.6 percent in March but food prices surged 1.5 percent. Among finished consumer foods, fresh & dried vegetable prices surged (13 percent), as did prices for eggs (8.6 percent) and fish (9.6 percent). Excluding food and energy prices, the PPI increased 0.2 percent in March after gaining 0.1 percent in the previous month. On a year-over-year basis, both the total PPI and the core (excluding food and energy prices) PPI moderated in March relative to the past several months. Declines in computer prices and tobacco prices helped hold down the overall index during the month.
Prices for intermediate goods and crude goods both posted 0.7 percent gains in March, less than the previous month. Excluding food and energy prices, intermediate goods prices rose 0.6 percent in March and now stand 2.8 percent above a year ago. Nonfood, nonenergy crude materials jumped 2.7 percent in March, slower than February's 5.5 percent spurt. Nevertheless, these prices are now up a whopping 29.8 percent from a year ago. Initially, higher crude goods prices reflect a strengthening manufacturing sector. If pricing power improves for manufacturers, they may eventually be able to pass along some of the higher prices to consumers. Despite the larger price increases in the CPI and the PPI, Fed officials don't appear overly concerned. Indeed, Greenspan once again noted this week that the CPI overstates the true rate of inflation.
Durable goods orders spurt in March
New orders for durable goods jumped 3.4 percent in March after an upward revised gain of 3.8 percent in February. Even after excluding such volatile components as transportation and defense, new orders were still up sharply. Among the major components, the largest gains were recorded in primary metals (7.2 percent), fabricated metals (5.2 percent), transportation (3.6 percent) and machinery (3.1 percent). Computers & electronics saw a minuscule 0.2 percent rise in orders; electrical equipment & appliances increased 0.8 percent. It certainly was a positive report with all major categories posting gains whether large or small. New orders have seen their ups and downs in the past year and have certainly helped to boost industrial production over the past 12 months. The February-March gains will go a long way to enhance production growth in the next few months.
Jobless claims decline
Jobless claims declined in the week ended April 17, but the drop was less than expected. In the first two weeks of April, new claims are once again above the previous month's average. This same pattern emerged in February. The positive news is that jobless claims remain well below 400,000. However, new claims will have to fall more dramatically in coming weeks in order to suggest that employment gains will continue to grow at a healthy rate.
The Bottom Line
Economic news was relatively sparse this week, but the indicators that were reported such as durable goods orders and the beige book reflected healthy gains. Though new jobless claims dipped after the previous week's spurt, they are really the only sore spot lately. The producer price index jumped in a similar fashion to the CPI due to food price hikes. Greenspan's comments spooked market players since he acknowledged that a 1 percent fed funds rate is not sustainable for the long run (what a shock!). Greenspan neglected to mention when the Fed does indeed intend to start raising rates. The Treasury market has already priced in a fed funds rate which is 50 basis points higher than the current 1 percent target.
Many key economic indicators will be reported next week, including first quarter GDP, consumer confidence, the employment cost index, the help wanted index and single family home sales. These are all likely to play roles in the Fed's decision-making at the next FOMC meeting on May 4th.
Looking Ahead: Week of April 26 to April 30
Monday
New single-family home sales jumped 5.8 percent in February to a 1,163,000-unit rate in February. Sales had increased in the Northeast and the West but declined in the Midwest and the South. Low mortgage rates in March are likely to have kept home sales percolating in March.
New single-family home sales Consensus Forecast for Mar 04: 1,169,000 unit rate
Range: 1,100,000 to 1,180,000-unit rate
Tuesday
The Conference Board's consumer confidence index edged down to 88.3 in March from a level of 88.5 in February. The confidence index was lower in February and March than in the three preceding months, suggesting that consumers were not yet feeling the benefits of an improving labor market.
Consumer confidence Consensus Forecast for Apr 04: 88.6
Range: 85.2 to 95
Existing single-family home sales rose 2 percent in February to a 6.12 million-unit rate. Despite the February gain, sales were still down from the September peak. Nevertheless, the overall selling pace remained robust. Except for the South, sales rose in all regions of the country in February.
Existing single-family home sales Consensus Forecast for Mar 04: 6.20 million-unit rate
Range: 6.00 to 6.50 million-unit rate
Thursday
New jobless claims fell 9,000 in the week ended April 17 to 353,000. This brought the 4-week moving average up to 347,000 from 344,750 in the previous week. The drop was smaller than expected by economists, but weekly jobless claims are difficult to adjust for seasonal variation, particularly around holidays.
Jobless Claims Consensus Forecast for 4/24/04: 345,000 (-8,000)
Range: 325,000 to 355,000
Real GDP expanded at a 4.1 percent rate in the fourth quarter of 2003. While this was a healthy pace, it appeared downright modest after the 8.2 percent growth pace recorded in the third quarter. Economists are looking for an improvement in the first quarter of 2004 due to a spurt in retail sales as well as increases in capital spending. Faster growth in the consumer price index suggests that the GDP deflator will also accelerate in the first quarter from the fourth quarter's 1.5 percent rate.
Real GDP Consensus Forecast for Q1 04: 5.0 percent rate
Range: 3.9 to 6.1 percent rate
GDP deflator for Consensus Forecast for Q1 04: 2.0 percent rate
Range: 1.2 to 2.7 percent rate
The employment cost index increased 0.7 percent in the fourth quarter with wages rising 0.5 percent and benefits increasing 1.2 percent. This follows the pattern of several quarters - benefits costs are rising faster than wages. Chances are good that wages will rise less rapidly than benefits in the first quarter of 2004 as well.
ECI Consensus Forecast for Q1 04: 0.9 percent
Range: 0.4 to 1.3 percent
The Conference Board's help wanted index has been bumping bottom for many months, and actually ticked up to 50 in February. The improving trend in the labor market suggests that help wanted advertising is probably rising somewhat as well.
Help wanted index Consensus Forecast for Mar 04: 41
Range: 40 to 42
Friday
Personal income rose 0.4 percent in February after gaining 0.3 percent in March. Slow employment growth coupled with modest gains in average hourly earnings are hampering wage and salary gains. Personal consumption expenditures inched up only 0.2 percent in February. Based on March retail sales, consumption expenditures are likely to record a sharp rise for the month.
Personal income Consensus Forecast for Mar 04: 0.4 percent
Range: 0.1 to 0.5 percent
PCE Consensus Forecast for Mar 04: 0.7 percent
Range: 0.3 to 1.0 percent
The NAPM-Chicago fell back to 57.6 in March from February's high pace of 63.6. The Chicago index was somewhat weaker than the ISM manufacturing and non-manufacturing indexes in March, suggesting that this region was not quite as strong as the country overall. Market players will be sure to monitor this index to see if the same conditions hold in April.
NAPM-Chicago Consensus Forecast for Apr 04: 60.5
Range: 57 to 62.8
The University of Michigan's consumer sentiment index decreased to 93.2 at the mid-April reading after increasing modestly in March. Consumers are probably holding out for more significant labor market improvement, although signs of increased consumer optimism were certainly evident in March retail sales!
Consumer sentiment Consensus Forecast for Apr 04: 94
Range: 93 to 95
Greenspan alludes to rising rates
