Financial Daily from THE HINDU group of publications
Wednesday, May 12, 2004
Financial Daily from THE HINDU group of publications Wednesday, May 12, 2004 |
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Money & Banking
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Govt Bonds Columns - Financial Scan Strong data ratchets up US Treasury yields S. Balakrishnan
NONE of the economists surveyed in pre-FOMC meeting polls thought that the Fed would raise interest rates at last week's meeting and it was right. They were practically unanimous, however, that there would be a considerable change in the tone and language of the customary post-meeting statement. Given the strength of the US economy as purveyed by the deluge of favourable data, the FOMC was expected to shift its stance from soft to a gradual tightening. But when will that happen? At its next meeting in June or beyond? Markets and analysts are in the grip of Fed fever, trying to gauge Mr Alan Greenspan's mind and those of his colleagues. As expected, the Fed thought it was time to remove the word "patient" to describe the time frame of action. In its usual stately phraseology, the FOMC said that "policy accommodation can be removed at a measured pace", meaning perhaps it will not do anything in haste and without due deliberation. Growth and inflation risks are evenly balanced, according to the Fed and although incoming inflation data is somewhat higher, long-term inflationary expectations are still well-contained and "the present accommodative stance is helpful in improving output and hiring at a solid rate." The latter was confirmed in last week's non-farm payroll of 2.88 lakh, almost matching that of the previous month, which itself was revised upward. Treasury bonds, which have long since discounted the change in Fed policy, sank to fresh lows pushing 10-year yields past 4.75 per cent from less than 3.75 per cent in March, fuelled not only by the strong jobs data but also a rising CPI. Mr Greenspan's remarks that disinflation (falling inflation) is over and pricing power is returning to producers did nothing either to help bonds. Mr Greenspan and his colleagues have said more than once that the present level of interest rates is extraordinarily low and it is unrealistic to expect they could be sustained indefinitely. This was tempered by references to the US economy's productivity gains and manufacturing and labour slack, which suppressed inflationary pressures and enabled Fed policy to stay put for an extended period of time. Is that about to end? It certainly looks so. Rising commodity prices are beginning to feed through to final products. With increasing tensions in West Asia, energy prices do not look like coming down much any time soon. The rising tide of demand from better global economic growth prospects is another negative for prices. A number of economists think the Fed is already behind the curve and should have acted earlier. The most aggressive of them is Mr Stephen Roach of Morgan Stanley, who thinks rates ought to be raised immediately - hold your breath - to 3.5 per cent. Others talk of a neutral interest rate level - neither accommodative nor tight - of which estimates range from 3.5 per cent to 5 per cent or thereabouts. Obviously, by any measure, one per cent Fed Funds, existing now, is ultrasoft. This week is crucial. Retail sales are due on Thursday and the CPI on Friday. Neither is likely to be interest rate-friendly. Look for 10 years to approach 5 per cent.
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