Issue 27 - August 11, 2005


Back to the Future

The Federal Reserve restored their benchmark Federal Funds rate to 3.50% with Tuesday's quarter point increase. Combined with the S&P 500's recent four-year high, this move returns the U.S. financial markets to levels last seen just prior to September 11th, 2001. Considering all that has transpired in these past few years, these developments should provide at least a modest sense of optimism with regard to the resilience and perseverance of U.S. financial markets.

Reports of Demise are Greatly Exaggerated

Just as Mark Twain quipped about his errant obituary, the U.S. economy is not dead. U.S. markets certainly face a number of daunting and wide-ranging challenges including fiscal and trade deficits and public and private pension insolvencies. However, corporate earnings and employment reports continue to show strength, and long-term investors see signs that basic U.S. business is being conducted profitably. Even the Internal Revenue Service has “earned” more than it had anticipated with withholding and receipts running well ahead of expectations.

It is also interesting to consider the following Bank Credit Analyst graph that relates to personal consumption as a percentage of household net worth.

As we wrote in our November 4th, 2004 newsletter, the traditional measures of personal savings have not kept up with the savings tools individuals now employ. Naturally if one were to believe people save nothing, then the only conclusion to draw is people are draining their home equity dry. But as the Bank Credit Analyst graph demonstrates, that is likely not the case. Credit card defaults, which now stand at multi-year lows, are generally a good barometer of individual financial health. An imminent housing bust would likely be predicted well in advance by a sharp spike in credit card defaults.

Greenspan Countdown

In just under 6 months, Alan Greenspan will turn over the reins to a new Federal Reserve chairman. We have argued he will not want his lasting legacy to be of an economy mired in a recession or of an economy running away in the grip of housing speculation. Through his clear and consistent message of “measured” increases Chairman Greenspan has clearly articulated his intentions of bringing modest restraint to those who are most influenced by short-term borrowing rates. His efforts to temper the growth of the economy have been offset by several factors - most noticeably the unprecedented behavior of long-term rates in response to the 250 basis point increase in the benchmark short-term rate. As the interest rate differential between short-term and long-term Treasuries continues to be been squeezed down towards zero, we need to consider the possibility and implications of a flat or inverted yield curve.

In normal times, investors demand a larger premium for lending money for longer terms. This is true for all asset classes. Recently, however, a combination of factors has combined to dramatically increase demand for longer duration assets even in the face of an overtly determined Federal Reserve. Whether or not all of this demand will continue when investors are able to achieve higher returns by investing in shorter term bonds remains to be seen. Banks and other financial institutions are negatively impacted by the narrowing margin of short and long term rates. They are not, however, the drivers of this behavior, they simply have to deal with it. Pension plans, hedge funds, and foreign central banks are frequently listed as prime suspects as buyers at any price. As such, these buyers will likely rethink the risk reward equation that a normalized Federal Funds rate implies.

There will be three more meetings of the Federal Reserve this year. We expect to see the Chairman make the most out of the opportunities and raise rates at least two if not three more times. Given that scenario and an economy which continues to operate at or above capacity, it is hard for us to imagine that long-term investors will not demand some sort of tangible premium in the form of higher long-term rates through the balance of 2005.


In this Edition

  • Back to the Future
  • Reports of Demise
  • Greenspan Countdown

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

26 - 06.09.05
Measured Conundrum
Possible Explanations
Implications of an Uncoupled Market

25 - 04.13.05
1st Quarter 2005:
Up, Down, Sideways
Calm on Top, Turbulence Below
What's on Deck?

24 - 03.09.05
Housing: Priority
#1 for the Federal Reserve
Calling the Top Again
Policy Implications

23 - 02.11.05
Interest Rates and the Federal Reserve
A New Demand Paradigm
No-Traditional Buyers
4% Looks Good
Chicken & Egg Market

22 - 12.02.04
Drooping Dollar
Not Everyone is an Investor
Implications for 2005
Putting the Euro in Perspective

21 - 11.04.04
Personal Savings
Absence of Rising Tide
US Elections

20 - 10.01.04
Coming or Going?
Speed Limit
Bond Market Showdown
Absence of Context

19 - 09.03.04
Aug '04/ Oil & Jobs/
Cooling of Hot Economy

More Past Issues
can be found in our

Newsletter Archive


Market Highlights

   07/29/05 06/30/05 03/31/05 12/31/04 12/31/03
DJIA US 10640.90 10275.00 10503.80 10783 10453.9
S&P 500 US 1234.18


1180.59 1211.92 1111.92
Nasdaq US 2184.83 2056.96 1999.23 2175.44 2003.39
EAFE Int'l Equity 1518.15


1503.85 1515.48 1288.77
5 Yr Treasury 4.151 3.731 4.21 3.649 3.231
5 Yr AAA Muni 3.24


3.29 2.79 2.45
10 Yr Treasury 4.322 3.972 4.512 4.257 4.225
10 Yr AAA Muni 3.75 3.54 3.920 3.64 3.6
30 Yr Treasury 4.432 4.163 4.731 4.817 5.01
30 Yr AAA Muni 4.35 4.3 4.580 4.58 4.54
EUR Currency 1.2091 1.2053 1.2958 1.3652 1.2612
JPY Currency 112.32


106.88 102.48 106.92
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