The Commerce Department announced that Q3 GDP growth was 1.6%, a level not
seen in three years when we were recovering from recession. Compared to a Street
estimate of 2.0%, this led to a rise in bond prices, on the expectation of
reduced Fed rates. Stocks declined as fear of recession mounted. There was even
praise for the Fed for not increasing rates last Tuesday.
It could prove, as we said earlier this week, that this so-called
"goldilocks" economy is in fact wearing a wig! Things are nowhere near as good
as most market commentators say.
In its recent statements, the Fed has been keen to warn of mounting
inflationary pressures. As we reported, well known outside commentators, such as
former Fed Chairman Paul Volcker, have also cautioned on inflation, even hinting
at political pressure to keep rates on hold.
In the face of these pressures and even published inflation above the Fed's
"comfort zone," the Fed has held rates.
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Although we have been urging the Fed to pay far more attention to what we
term as stealth inflation, we can understand why the Fed (with one dissenting
vote) would want to hold rates as the November elections loom.
We also believe that, with its most sophisticated analysis and access to
official information, the Fed, while perhaps not seeing the final figure, had at
least a "strong indication" of the way things looked on GDP growth. We can now
well understand that the Fed would not want to spook voters or the bond and
stock markets at what looks increasingly like a most delicate economic turning
point-a turning point where we believe we are facing not just recession but
stagflation.
The 10-year bond now stands at a yield at some 60% of the Fed rate of 5.25 %.
If the Fed had raised its key rate to 5.50% the differential to the 10-year bond
would have risen to almost 1.00 %. Historically, such a wide differential has
heralded recession.
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interest rate plays.]
Today, CNBC announced that the fall in house prices had cut some one trillion
dollars from the wealth of U.S consumers. The Fed knows that the "property
centric" position of U.S. consumers is still uncertain. But, it remains a major
concern.
So far, some 60% of the Dow 30 industrial component companies have reported
quarterly earnings. A heartening 74% of them came in ahead of Wall Street
estimates, with only some 15% disappointing on the downside.
This was good news, but the stock market hardly "roared" as it lurched to
what the media describes enthusiastically as, "new record highs."
With geopolitical tensions having appeared to lessen of late. With oil having
dropped considerably; with good figures on corporate earnings, jobs and on
government revenues, why is it that the stock market has failed to roar?
We believe the market is secretly more concerned about inflation than most
financial commentators admit. Every portfolio manager and private investor knows
that inflation in his or her own personal expenses is way above the official
CPI.
Despite the good news, investors are privately and increasingly concerned
about inflation and a resultant rise in Fed rates.
Of course, readers of FIR and MoneyNews will know the CPI is based upon
officially "cooked books" (the inflation lie), with a heavy bias to the
downside. They will also realize that what the media now describes as new
historic stock market highs are not what they appear.
Even discounting for official inflation, the Dow would have to reach some
14,000 to equal its January 2000 peak. To reach its 2000 peak, measured in terms
of "real" money (gold) the Dow would have to reach some 23,000! Our readers will
ask, "Then what sort of a record is a mere 12,000 on the Dow?"
We believe that an increasing number of investors share our concern about
stealth inflation.
[Editor's Note: The
government is manipulating inflation data. Read this free report.]
We believe the Fed faces an agonizing choice between stock markets
entertaining low morale, the increasingly clear prospect of a slowing economy
and the outlook for increasing inflation, even measured by the official CPI. We
believe the reality is worse, much worse, as stealth inflation is far higher
than most investors, businessmen or politicians can face, without panic.
In short, we feel the Fed is staring right into the face, not of a soft or
hard economic landing, but of the most worrying of economic conditions, that
haunted us in the 1970's-STAGFLATION!
So what will the Fed do? We think the Fed will hold rates until after the
election. Then, it will gradually raise rates, while talking markets up.
As we go to print, the new Treasury Secretary, Henry Paulson, has just been
interviewed on CNBC. To one early question, he replied, "Well, I'm certainly no
political expert. …" He then went on to talk up the dollar, the U.S. economy and
financial markets in a masterfully political manner. [You don't rise to the top
of a modern investment bank, like Goldman Sachs, without a great expertise in
politics!]
Interestingly, Mr. Paulson is now in charge of the most important
"President's Working Group." This group, sometimes referred to as the "Plunge
Protection Team", included the heads of the Federal Reserve, Securities and
Exchange Commission and the Commodity Futures Trading Commission.
A major Wall Street Journal article (Oct 23) described this committee as, " a
significant lever of influence outside the Treasury bailiwick," The article went
on to quote Rob Nichols, a former Treasury spokesman as saying This committee
is, " where he [Paulson] can shape the debate," on keeping the U.S. economy and
capital markets competitive.
According to the article, Mr. Paulson has stepped up activity on this
important committee very considerably.
We feel this increased emphasis is well advised in order to cope with the
troubled economic time we see looming ahead - a time when markets could easily
become spooked and panic.
Editor's Notes:
