S. Balakrishnan

MORE often than not, bets against the odds succeed in financial markets.

It was so once again last week. Job creation in the non-farm sectors of the US economy was forecast to be over 2 lakh.

Actual was only about half of that - 1.10 lakh. But, in complete contradiction to the payroll data, the unemployment fell to 5.2 per cent from 5.4 per cent. Again, this has been the pattern for some months now. The sources of data for the two statistics are different, giving rise to conflicting information in the monthly reports.

Bonds, which had been primed for a reasonably upbeat jobs figure, promptly rose. The 10-year yield dropped from 4.6 per cent levels to below 4.5 per cent.

The market did not feel threatened even by the subsequently-released ISM data on manufacturing, which showed a sharp jump in the prices paid component.

Yields continued to remain soft. The big question, as always, is whether the US, is on the threshold of higher inflation. The bigger question is what is the Fed's view and what its actions are going to be. Data and reality do not shape markets as much as expectations and policy responses.

In the G-7 economies, the US is still the fastest growing economy. But it is also characterised by the most excesses - a close to zero savings rate, deteriorating fiscal position and a massive trade imbalance. As long as foreigners continue to pour money into the US, the deficits do not matter. And, fact is that they hardly seem to care. It is all a confidence game.

Last month's statistics showed that well over $90 billion flowed into buying US securities - far above the trade deficit of below $60 billion.

Clearly, foreigners are voting America with their chequebooks. That explains why, despite the US's over-leveraged fiscal and trade position, the dollar has managed retrieve ground and bond yields remain low.

The sustained appetite for US assets among central banks and non-American investors is, of course, a source of great comfort for the Government and the Fed as it has stopped long-term interest rates from rising much and staved off a dollar collapse.

The long-term solution is clearly to raise the savings rate and the Bush Administration thinks privatising Social Security is the answer (although in close questioning, Mr Greenspan admitted that there is no certainty that privatisation will lead to more savings).

On the inflation front, there was some good news for the Fed. The core Personal Consumption Expenditure Index rise stayed at 0.2 per cent. There is a significant chance that oil prices will recede from their recent highs. These factors, combined with lukewarm job creation, may very well allow the Fed to cling to its "measured pace" rate increases of 25 basis points.

But the Fed officials' jawboning, including that of Mr Greenspan, is likely to halt the fall in bond yields and temper overenthusiasm in the markets.

(This article was published in the Business Line print edition dated April 6, 2005)
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