Commentary - Just a Conundrum or Real Economic Slowdown
Chairman Greenspan in a speech yesterday tried to rationalize the so-called conundrum at the long-end of the bond market with a laundry list of theories. The puzzlement is that since the Fed started tightening at a 25-basis points clip since May 4 2004, the Fed Funds rate has gone up 200 basis points from 1.00% to 3.00% while confoundingy the 10-year treasury yield has gone down almost 100 basis points from 4.89% on June 11 2004 to 3.95% yesterday (see the chart). The Chairman cited the following as the possible reasons (1) expected slowdown in the global economy (2) pension funds' purchase of long-duration treasuries (3) foreign demand for long-end treasuries (4) globalization which dampened inflation and risk premium. However, the Chairman systematically dismissed each of them, and thus admitted being confounded by the very subject he should be the master of. Btw, the Chairman forgot to mention the convexity trade by MBS holders as another possible reason.
I applaud the Chairman's honesty but I sense that he is being a victim of his own dogmatism. Greenspan has been the most vocal, and given his position in the bureaucratic hierarchy, the most consequential productivity-bull. He has said time and again that high productivity growth was brought in my technological revolution of the past decade and would continue for a foreseeable future. The outcome of that supply shock is a goldilocks economy with low inflation, high GDP growth, and the absence of economic cycles. The decade long expansion of the 1990s was the manifestation of Greenspan's mantra. Perhaps the Chairman is expecting another period of prolonged expansion and that is why he dismissed with scant explanation the possible reason (1) for the "abnormal" behavior of the bond market.
The possibility of a slowdown in the U.S. economy cannot be dismissed off-hand. There are many ominous signs on the horizon that suggests the end of honky dory days. (1) the ISM index has started to trend down to the "red zone" area. ISM has been a very reliable predictor of the trends in the U.S. economy (see the chart). (2) the U.S. economy emerged from a very shallow 2001 recession without shedding all the imbalances - the twin imbalances (budget and current account deficit) have become even worse making the U.S. economy very vulnerable to shocks. (3) The U.S. consumers have voraciously consumed anything and everything that is produced in the world. That can last only so long.
I applaud the Chairman's honesty but I sense that he is being a victim of his own dogmatism. Greenspan has been the most vocal, and given his position in the bureaucratic hierarchy, the most consequential productivity-bull. He has said time and again that high productivity growth was brought in my technological revolution of the past decade and would continue for a foreseeable future. The outcome of that supply shock is a goldilocks economy with low inflation, high GDP growth, and the absence of economic cycles. The decade long expansion of the 1990s was the manifestation of Greenspan's mantra. Perhaps the Chairman is expecting another period of prolonged expansion and that is why he dismissed with scant explanation the possible reason (1) for the "abnormal" behavior of the bond market.
The possibility of a slowdown in the U.S. economy cannot be dismissed off-hand. There are many ominous signs on the horizon that suggests the end of honky dory days. (1) the ISM index has started to trend down to the "red zone" area. ISM has been a very reliable predictor of the trends in the U.S. economy (see the chart). (2) the U.S. economy emerged from a very shallow 2001 recession without shedding all the imbalances - the twin imbalances (budget and current account deficit) have become even worse making the U.S. economy very vulnerable to shocks. (3) The U.S. consumers have voraciously consumed anything and everything that is produced in the world. That can last only so long.
posted by The Poster | 6:14 PM
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