Good Evening: U.S. stocks managed to finish with modest gains Thursday, though the performance by the major averages could have been better considering today’s positive economic news. Then again, it was this same set of data that helped push Treasury yields quite a bit higher, and therein lies the rub facing investors. With all the paper slated to be issued by the Treasury in the coming months, any improvement by the economy may lead to the type of higher interest rates that could choke off any recovery. And if the economy instead steps on the green shoots by continuing to stagnate, then equities will at best go sideways (and could roll over to the downside). Perhaps this boxed-in feeling among investors is why volume has trailed off in recent weeks and why prices have much such little headway in either direction. Adding to this sense of unease is an aspect of President Obama’s regulatory reform proposal that could politicize (and thus compromise the independence of) the Federal Reserve.
Overseas markets were once again weak last night, but our stock index futures were only a bit lower as jobless claims hit the tape this morning. Initial claims remained above 600K, but continuing claims declined for the first time in what seems like forever. Of course, what we don’t know is how much of this reduction in ongoing claims is due to the stoppage of benefits once the long term unemployed have “timed out” of the program, but the news is welcome nonetheless. Stocks were hovering only slightly above unchanged when both the Philly Fed and LEI figures came in well above expectations. Manufacturing in the Philadelphia Federal Reserve district still fell in May, but this stat came close enough to the zero (neutral) mark that some eager investors thought they spied “growth”. This notion was only reinforced when the Leading Economic Indicators figures for May rose a full 1.2%. The BAC-MER economic team was impressed enough to opine that the U.S. economy is now “closer to the trough” (see below).
Equities immediately popped once these data points were made public, and the major averages were up 1% or so within minutes. With recent economic numbers on the weak side and with the indexes down approximately 5% from last week’s highs, the stage was set for a short-squeezing explosion to the upside. Not quite; the rally fizzled and the averages went more or less sideways into the closing bell. Perhaps what doused the match before it could light the fuse was a spike in interest rates. A combination of the firm economic data, a potential change in how LIBOR will be calculated, and word from the Treasury that they’ll need to raise a few billion more than thought at next week’s auctions caused bond bids to wilt on Thursday. Yields rose between 9 and 17 bps as the middle of the yield curve bore the brunt of the damage. Those higher rates seemed to help the dollar while leaving most commodities relatively unscathed. The CRB index finished almost on top of Wednesday’s closing level.
At the beginning of this year, the S&P 500 was in the low 900’s when I came out with a forecast for 2009. I guessed that the S&P would trade in a wide range, with 1000–1100 representing the top end and the November 2008 lows at the bottom end. I also speculated that there was “a better than 50/50 chance” we would set new lows in 2009, and while this aspect of my idle musings came true, I honestly thought we’d test 1000 first. As we approach mid year, I see no reason to pen a different opinion. Still, the next six months look like an especially tough call to make with any degree of confidence.
With volume and volatility already on the wane, and with the summer doldrums directly ahead, it seems investors have already conceded that going to the beach, lowering the handicap, and spending some time with the family will take priority during July and August. A weak economy that continues to deleverage while the monetary and fiscal spigots are wide open should be the subject of more attention by market participants. If today’s desultory trading on the day before a quarterly expiration is any indication of what’s to come, however, then this might be a frustrating summer for those who like to ride trends. I think I will counter-punch by buying dips, selling rallies, and using tight loss parameters until the picture becomes less murky.
There are a myriad of reasons why volatility could return without much advance notice, and one of them became apparent after analysts and journalists had a closer read of Mr. Obama’s 85 page treatise on the subject of financial regulatory reform. It seems that Team Obama would like to empower the Fed, but — and here’s the catch — at the cost of giving up some of its independence. The Fed, it seems, will have to get written permission from the Treasury Department before acting as lender of last resort in the future. Vince Farrell, Art Cashin, BAC-MER, certain reporters, and a host of others all wondered if Mr. Obama was serious in attempting to politicize the Fed (see below). This question received the following answer by the administration’s own, Larry Summers, in an interview today:
“That type of lending is ultimately putting taxpayers at risk,” Lawrence Summers, director of the President Barack Obama’s National Economic Council, said in an interview with Bloomberg Television today. “There should be some democratic accountability.” (source: Bloomberg article below)
On the surface, it sounds like a reasonable request. For many reasons, it isn’t. Mr. Summers didn’t say whether this “accountability” was meant to be democratic with a small d or a big D, but in either case it is an unwelcome threat to the independence of our central bank. Now I’m no fan of an activist Fed, and we’ve had only one hard money Chairman (Volcker) at its helm during the last four decades. But requiring the Fed to report to, or be influenced by, either the executive or legislative branches of our government is just bad policy. I would rather see the U.S. return to the gold standard (Jim Grant’s idea) or even abolish the central bank entirely (Bill Fleckenstein’s idea) before I would want to see the Fed become politicized.
At a time when Treasury issuance is well above flood stage, the U.S. is more dependent than ever upon the perception of an independent Fed. Our formerly generous foreign creditors have already expressed some displeasure with the deficits that politics and a recession have conspired to swell over the banks of reason. If our creditors feel the green ink of monetary policy will be mixed by the same hands that brought so much red ink to our fiscal policy, then won’t they think twice about that next purchase of Treasury securities? If Mr. Obama is unhappy with the Federal Reserve Board, he can appoint a new Board members when vacancies open up — or even a new Chairman when Mr. Bernanke’s term expires. I also have no problem if Congress wishes to impose shorter term limits for Fed appointees (though we should demand similar “time served” limits for Congressmen and Senators, too). So, if we’re going to have a central bank at all, let’s keep it independent. In the modern era of easy money, it’s the only form of discipline the institution has left.
— Jack McHugh