Market Features
What a Week: Bear Rout
Liz Rappaport
12/15/06 - 05:30 PM EST
If last Friday's jobs report lent credibility to the bulls, this week's retail sales and inflation data sealed the deal. The bears are on the run.
The turnkey for the attitude adjustment was the bond market losing faith in its bets on rate cuts and recession. Through much of autumn, the Treasury market's conviction that rate cuts were coming left a blemish on many investors' and economists' bullish outlook.
The onus seemed on the soft-landing optimists to prove the weakness in autos, housing and manufacturing would not spill over into the rest of the economy. The burden of proof has shifted to the bears, and they are having a harder time showing that growth is weak, and that housing could still do widespread damage. For now, Goldilocks is in the house and sitting at the table.
Capped by a flat reading in the headline and core consumer price indices for November, the week was filled with soft-landing numbers. Initial jobless claims slipped for a second week in a row. Retail sales for November soared past consensus expectations, and October's sales were revised upward.
Mortgage applications had another blockbuster week. Industrial production jumped more than expected, and foreigners are still buying our Treasury bonds. Almost fading into the background this week was Tuesday's meeting of the Federal Open Market Committee, which left the fed funds rate steady at 5.25% for the fourth meeting in a row.
Inflation: Merely a Flesh Wound?
The tame November CPI leaves stock investors believing in the so-called Santa Claus rally, but the fifth consecutive soft inflation reading doesn't mean core inflation couldn't turn up again. Indeed, a resurgence of core inflation could be the biggest threat to the stock market in 2007. "The data do not seem consistent with the ongoing pressure on commodity and labor costs," writes Ethan Harris, chief economist at Lehman Brothers. He adds that the Fed will be watching for its preferred inflation measure, the core personal consumption expenditures deflator to confirm the CPI's decline. Thus far the core PCE has not come down as fast or furiously as CPI on a monthly basis. Furthermore, both core PCE and core CPI are above the Fed's so-called comfort zone of 1% to 2% on a year-over-year basis. So, while the Fed and Chairman Ben Bernanke are likely thrilled to see the trend in CPI, their hawkish talk and tightening bias probably won't go away. The fed funds futures has finally taken the hint about no imminent rate cuts. That market didn't even budge after the low inflation print came out Friday. Bonds did rally, but came off the boil later in the day. The fed funds futures market puts 4% odds on a cut in January; 24% in March; and 64% in May, according to Miller Tabak. As of last Friday, the market had slightly higher 8% odds on a January cut; 32% odds for March; and 84% for a May cut. The Treasury bond market sold off sharply on the CPI report, but reversed course in the middle of the day -- possibly reflecting a hint (of all things) inflation concerns, writes Randy Diamond, trader at Miller Tabak. Supporting Harris' concerns about commodity prices, the Journal of Commerce's index of industrial materials reached a new all-time high Friday and the Cleveland Fed put out a weighted index of core inflation that shows "true" core inflation registered a 0.2% gain, writes Diamond. The yield on the 30-year bond added 8 basis points this week to yield 4.72%, while the 10-year added three basis points to yield 4.59%, and the two-year jumped four basis points to yield 4.72%. For the time being, evidence of excess cash is boosting the prices of financial assets without spilling into consumer goods. It's an easy win for stocks. "We can have or excess liquidity cake and eat it, too," as Michael Darda, chief economist at MKM Partners says. |
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