Markets often get ahead of themselves and the US economic picture remains clouded. A curious thing happened after the Federal Open Market Committee's most recent 50bp monetary easing on November 6, despite the Fed's pronouncement that "risks are weighted mainly toward conditions that may generate economic weakness," market interest rates have moved appreciably higher and expectations of future interest rate cuts have dissipated. For instance, the Eurodollars futures market is now predicting three-month rates in June 2002 of 2.79 percent (consistent with a federal funds target rate around 2.50 percent) as opposed to three-month rates around 2.09 percent (implying a federal funds target rate below two percent) around the time of the Fed's move. December federal funds futures contracts now suggest there is only a 33 percent chance of an additional 25bp easing by the end of the year. As expectations of additional monetary stimulus have been removed from the short-end of the Treasury yield curve, longer-term yields have crept up also - the yield on the long bond recently jumped from 4.86 percent to 5.29 percent in one week. Even the yields on two-year Treasury notes have escalated some 70bps since November 6.
Does
this really mean the current economic scenario - which
invariably will be deemed a recession unless Americans take to
the shopping malls in record droves this holiday season - will
be nothing more than a short-lived economic correction?Taking
their cue from the fixed-income markets, equity markets seem
to regard this a likely scenario. The Standard and Poor's 500
stock index is up some 20 percent from its recent 21 September
lows. Stock market bears, however, are quick to point out that
the S and P stock index climbed more than 20 percent above its
March 2001 lows in the spring of this year months after the
Fed initiated its sweeping course of monetary easing on
January 3. Also on the positive side, the US dollar has
remained quite resilient, having retraced most or all of its
post - September 11, losses. The greenback remains relatively
durable vis-à-vis the euro, a curious phenomenon given the
widespread forecasts predicting the eurozone's economy will
outpace economic growth in the US in 2001 and 2002. Moreover,
energy prices are dropping considerably as the price of oil
has fallen to around US$ 20 per barrel. OPEC remains in a
"we-won't-blink-first" stalemate with non-OPEC
members regarding cuts in production. This clearly signals
less financial pressure on the US consumer in terms of being
able to finance energy needs and also contributes to a general
lack of inflationary pressures.
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