Aaron Task
As noted above, GDP is expanding, average hourly earnings are up 3.1% in the past year, consumer credit rose at an annualized rate of 3.8% in the first quarter, and financial assets have been rallying, sharply in some cases.
Among price measures, the GDP price deflator rose 2.5% in the first quarter, while the consumer price index was up 3% on a year-over-year basis in March, having seemingly bottomed in June 2002. Meanwhile, the March producer price index was up 4.2% year over year after hitting a 50-year low in May 2002. Given weakness in other inflation measures (core PPI is up only 0.9%), corporations' lack of pricing power, and Japan's downward spiral, the Fed is justified in declaring its vigilance against deflationary threats. A more foreboding explanation of low Treasury yields goes like this: The Fed helped foment an equity bubble in the late 1990s by not raising margin rates or more forcefully discouraging the notion of a "Greenspan put." After "popping" the bubble in late 1999-early 2000, the Fed subsequently lowered rates to extraordinary levels in order to fuel the housing market, thus keeping consumer spending afloat, particularly after the Sept. 11, 2001, terrorist attacks. Low rates also presumably have allowed households and corporations to repair tattered balance sheets. More recently, and with the Bush administration's tacit support, the Fed has kept rates low in order to weaken the dollar, which helps U.S. exporters and results in higher prices for imported goods, i.e. fights disinflation/deflation. Trouble is, the Fed is running out of rate-cut bullets and is now moving on to alternative measures, possibly including buying long-dated Treasuries. This may explain why Treasury yields are so low, but the Fed has a lot of balls in the air right now, simultaneously trying to "prop up" Treasuries and, indirectly, stocks, while engineering a "gradual decline" in the greenback. Even if not tomorrow or next week, the threats are that the dollar's decline will accelerate and/or inflation will re-emerge, forcing the Fed to consider raising rates. Either scenario has ominous implications for stock and bond bulls alike.
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