April 23, 2004
The Hawks Are Circling, But Will They Land in 04?

Following last weeks stronger than expected CPI report Fed futures began pricing in a rate hike by August. Greenspan confirmed this week that deflation is dead, and that interest rates will ‘eventually’ have to rise. Since April 1 Treasury yields and mortgage rates have risen rapidly, and – despite a strong rally in stocks yesterday - all three major US stock indices are trading lower today than on April 1. Do these developments mean that the Fed will soon tighten and that the return of the great bear market is at hand?

Precious metals have been slammed and the dollar index is trading near its highest level of the year (the dollar hit its highest level versus the Euro yesterday since Nov 26).  China is aggressively acting to curtail inflationary pressures and, with or without a rate hike, US economic growth should slow in the second half of 2004 as fiscal and monetary stimulus measures ebb.  Do these developments mean that the Fed will refrain from hiking interest rates anytime soon?

Questions Not Easily Answered

On Wednesday JP Morgan said that the Bank of Canada will raise interest rates in October. Today CIBC says that one more BofC rate cut is coming.  Eve after last weeks CPI report Goldman was arguing that the Fed would remain on hold until 2005. Even after Greenspan’s comments this week an HSBC analyst says that the Fed will not raise interest rates at all.  Bob Ried thinks stocks will do well regardless of any possible interest rate hikes.

Although warning of housing bubbles and the threat of rising interest rates, the IMF offered a rosy outlook on the global economy this week. President Bush may actually be the benefactor of a pre-election rate hike?  Abby says that “We see that the U.S. economy is staying stronger, for longer, than many had expected”.  Do these developments mean…What, if anything, do all these developments mean?

To make a long/convoluted set of developments short, the outlook for US interest rates is what it has been for some time: unclear. Moreover, until the interest rate picture becomes clearer and/or the earnings situation (which is that of strength regardless of the high valuations) changes, the outlook for US stocks remains the same: the bears are still in limbo (see March 18).

In conclusion, one set of speculations I tend to agree with (but wouldn’t invest on), comes from CIBC:

“By the time a rate hike would be politically feasible, it is doubtful whether the Fed or the bond market will feel the need for one. If a bare fiscal cupboard doesn’t break the consumer, soon-to-be-$40 per barrel oil will. By second half of the year, US GDP growth will likely average below 3%, defusing the inflationary concerns that have recently gripped the Treasuries market.”  PDF File

In the case of Canada, one economist sees a cut while another sees a hike. In the case of US – cuts probably done with – the debate is centered on when the next hike will arrive.  However, unless the Fed hikes before the election, you have to wonder whether or not they will hike at all…