Many key factors shaped the behavior of the financial markets this past week and helped equities to recover from Tuesday's weakness.
The most important factor came from economic reports that provided compelling evidence to indicate businesses are highly confident in the outlook for the U.S. economic expansion. Evidence of such surfaced on several fronts:
Initial jobless claims: The four-week moving average fell to 309,000 from 312,000 the previous week. Claims are now at their lowest level since November 2000 and well below the six-month average of about 340,000. The data point to a pickup in labor demand. A similar signal was given last year when payroll growth increased to 180,000 per month from a slight contraction in 2003. The current level of claims is consistent with job growth of closer to 225,000 to 250,000. There will be ups and downs in the monthly payroll figures, of course, but an uptrend will likely show through before long.
Help-wanted advertising increased in the nation's newspapers during January, the Conference-Board reported, going against the grain of the secular decline in newspaper advertising (ads have migrated to the Internet).
Consumers' assessment of the present situation reached its highest level in about three-and-a-half years, the Conference Board reported in its release of February consumer confidence data. The findings are similar to those of the University of Michigan's survey, in which the assessment of the current situation is now at its highest level since December 2000. Changes in the assessment of the present situation tend to correlate well with changes in the condition of the labor market.
Orders and shipments of non-defense capital goods orders rose sharply in January, increasing 2.9% and 3.7%, respectively. The data put these categories more than 30% above the fourth-quarter average. This is a sure sign of strength in business spending, and it squashes the view that last year's strength was related to expiring tax incentives. The shipments data are particularly important, as they are plugged directly into the calculations of the gross domestic product.
Commercial paper issuance continued to expand in the latest week, and the total amount of commercial paper outstanding is now at its highest since February 2002. This is a sure sign that businesses are seeking working capital for inventory investment, capital spending and hiring. Bank loans continue to expand too, as is usually the case when commercial paper issuance expands.
Positive news was also seen on the geopolitical front, as President Bush scored a successful trip to Europe, raising confidence that
will be used to confront problems such as Iran and North Korea. There were also indications on progress in implementing the so-called road map to peace in the Middle East.
More Rate Hikes, but Still Measured
The week's economic news was strong enough to raise the odds of future interest rate increases by the
. Yet the data were not strong enough to boost the odds of more aggressive actions from the Fed. In fact, the minutes of the Federal Open Market Committee's Feb. 2 meeting -- released this past week -- indicated no urgency by the Fed to accelerate its pace of interest rate increases, mirroring the recent congressional testimony of Fed Chairman Alan Greenspan.
Continuing to bolster the chances of additional interest rate increases are financial conditions. Ever since the Fed's first interest rate hike in June, financial conditions have loosened: Equities have rallied, bond yields have fallen, credit spreads have tightened, the dollar has weakened, and lending standards have loosened. These transmission effects are working against the Fed's rate hikes, supporting economic growth. This increases the need for the Fed to raise interest rates, and it is all the more reason for the yield curve to flatten. Continued Fed rate hikes will likely boost the yield on the 10-year Treasury note at some point.
Strategies for Higher Rates
Even if the forecast for a higher yield on the 10-year is wrong, investors can benefit from various investment strategies that benefit from the strong economy, which is expected to be the cause of the rise in the 10-year's yield. For example, in 2004, investors could have bought basic-materials stocks and bet on a flattening of the yield curve. Investors could also have bought junk and emerging-markets bonds, on the notion that increased cash flows from the strong economy would help these sectors.
Although I believe that investors should continue to make bets on rising U.S. rates, in 2005 investors should slowly trade up on the credit quality scale.
Interesting is the recent contraction of the monetary base, which posted its biggest decline since early 2000 in the latest week and has contracted slightly over the past five months. This is sowing the seeds for reduced inflation next year in real and financial assets, as it will ultimately reduce the amount of money available to buy stocks, bonds, commodities and so forth. It will also help to boost the value of the dollar, as the amount of U.S. dollars in the global financial system will become relatively scarcer. This is next year's story.
Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. His first book,
The Strategic Bond Investor
, will be published in July by McGraw-Hill. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. He appreciates your feedback and invites you to send it to