Same venue, different speech, similar result.
Chairman Ben Bernanke spoke Tuesday morning at the 2007 International Monetary Conference from Cape Town, South Africa. Like last year, when he spoke at the same conference in Washington, D.C., and sent the
Dow Jones Industrial Average
tumbling 199 points, his comments seemed to spark a stock market selloff Tuesday.
But this time around, the selloff was milder and a mere coincidence that Bernanke was involved at all.
"This is about bonds ticking back up to 5% levels," says Bill Nichols, trader at Bear Stearns. Rising yields ignite chatter about the level at which Treasuries become attractive relative to stocks, from a risk-reward perspective, he says.
After trading as low as 13,551 intraday, the Dow closed down 0.6% to 13,595.46. The
finished down 0.5% at 1530.95 vs. its nadir of 1525.60; the
slipped 0.3% to close at 2611.23.
Among the biggest losers Tuesday were rate-sensitive names in the utility sector like
, and REITs like
Apartment Investment & Management
. The Dow Utility Index fell 1.5% and the Dow REIT Index lost 1.8%.
In the bond pits, the yield on the 10-year Treasury bond continued to rise as strong economic news removes most estimates for a rate cut. The Institute for Supply Management's read on the service sector at 59.7 was more robust than analysts had expected as its jobs component, new orders, and prices paid elements rose. The 10-year closed the day yielding 4.97%, compared with 4.93% at Monday's close.
Last year, the markets were adjusting to a new interest rate environment and a new Fed chairman who seemed
inconsistent in his first months on the job. This year, the markets are likewise adjusting to a new interest rate paradigm, but traders are in synch with Bernanke.
"The conundrum of the failure to communicate is over," says T.J. Marta, fixed-income strategist at RBC Capital Markets. "The bond market is finally willing to take the Fed at its word and has seen enough data to satisfy its own mind that the way the Fed sees the world is appropriate for now."
The Fed is essentially about data-dependence, and Bernanke said Tuesday morning that the economy is likely to rebound from its weak first-quarter trough. But it was classic "on the one hand, on the other" rhetoric.
The chairman spent much of his speech discussing the ongoing recession in the housing market. "The adjustment in the housing sector is still ongoing, and the slowdown in residential construction now appears likely to remain a drag on economic growth for somewhat longer than previously expected," he laments.
But Bernanke later noted that solid income growth and relatively low mortgage rates "should ultimately support the demand for housing, and at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system."
On inflation, Bernanke repeated the now-familiar mantra that "although core inflation seems likely to moderate gradually over time, the risks to this forecast remain to the upside."
In particular, "the continuing high rate of resource utilization suggests that the level of final demand may still be high relative to the underlying productive capacity of the economy."
"Resource utilization" is code for the labor market. Indeed, the Fed's persistent reminders that the labor market is too tight to consider any rate cuts has finally not only swayed the Treasury market and fed funds futures traders, but even some of Wall Street's last holdouts on the rate-cut theory.
"Mmhh, crow," writes Jan Hatzius, chief U.S. economist at Goldman Sachs. It's the surprising strength of the labor market amid three quarters of below-trend growth that the economist says he missed.
On Tuesday, Goldman pulled the plug on its forecast for Fed easing in 2007 and increased its estimates for second and third-quarter GDP readings to 3% from 2% and to 2.5% from 2%, respectively.
Similarly, Merrill Lynch's permabear economist David Rosenberg wrote Monday that he now believes the Fed will not cut rates any time this year. Rosenberg writes that he believes the Fed is willing to sacrifice slower growth to get inflation to 1.5% -- the middle of its 1% to 2% comfort zone.
"It is plain to see that only when we either see a major setback in the capital markets or an economic slowdown that precipitates a move to a 5% unemployment rate or a 1.5% core inflation rate, only then will the Fed believe it is in a position to shift its bias, let alone begin to cut rates," writes Rosenberg.
For economists, admitting to a flawed forecast is not easy given that their reputation, not their trades, are what they have to go on.
Now that the permabears and the bond market are in line with the Fed, rates could go even higher. Marta's forecast puts the 10-year at 5.45% by the end of the year. He predicts inflation and inflation expectations may creep higher as the economy rebounds.
As for the stock market, many investors remain optimistic and even encouraged by a down day.
"As prices rise, investors first look for reasons to sell, later to buy," writes Barry James, president and CEO of James Investment Research. He notes that following a long-awaited S&P 500 record, the stock market usually experiences about 11 weeks of gains.
Only three Dow components,
Procter & Gamble
gained ground on the day.
The Dow was hit by more than 1% losses in
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
to send her an email.