Issue 20 - October 1, 2004


US Economy: Coming or Going?

The third quarter of 2004 has indeed been challenging to anticipate. The quarter has witnessed unprecedented movements in both the bond and oil markets, the latter of which surged some 35% in just these past three months.

The Problem with Going the Speed Limit

We have all felt the sensation of slowing down from a period of driving at extended highway speeds to driving at surface street speed limits; it feels like you are just sitting still. The current debate surrounding the financial markets centers on whether the economy is slowing down to a traditional, sustainable GDP speed limit or whether it is grinding down under the weight of increasing interest rates and commodity prices. Is the economy just sitting still, or is it performing at a reasonable, yet slower, pace? Certainly, higher oil and other commodity prices will act as a drag on the economy to some extent. However, commerce does not exist in a vacuum. Productivity has not been outlawed. Furthermore, while China’s appetite for natural resources has been a factor in the rise of oil, their trade with the farmers of Washington State, as an example, has resurrected an entire industry and West Coast ports are all now running at peak capacity. There will certainly be industries whose margins will decline with the rise in short-term rates, but this return to neutral is a significant and encouraging milestone for a U.S. Economy that has been through so much these past 5 years.

Bond Market Showdown

The Federal Reserve has now raised short-term interest rates at each of their last three meetings, bringing the Federal Funds Rate up to 1.75%. Despite these increases, real rates of interest are still in net negative territory. In an effort to clearly telegraph their intentions, each District Fed President has also come out on the record as saying that further increases are on tap until the Funds rate returns to a neutral state of 3%-5%.

The bond market however has turned a deaf ear to these signs. Aggressive long bond buyers have made the bet that the slowing of the economy will preclude the Federal Reserve from normalizing rates beyond one additional increase. In fact
Merrill Lynch is on record as saying that Fed Funds will remain at 2% through all of 2005. This debate is shaping into an old fashioned, winner take all showdown.

An Absence of Context

Current bond market enthusiasts need to be better students of history. There is nothing normal or sustainable about negative interest rates. The Fed Funds rate stood at 3% on the first of September 2001. It had been at 6.5% in January of 2001. The Fed had appropriately positioned itself to help markets unwind the bubble. However, September 11th changed the landscape dramatically. By January 2002,
the fed had eased another 1.25%, bringing the short term rate to 1.75%. Further
economic slowness prompted the Fed in September 2002 to lower that rate to 1.25%. These 9/11 inspired reductions left the Federal Reserve in an awkward position. It was no longer in a position to provide much in the way of further stimulus and it had created a substantial hole from which it would ultimately have to dig out from in
order to be an effective steward of the U.S. financial system.
It is a lack of appreciation of the unique set of circumstances which took us
below 3% which is creating a sense of permanent entitlement to these
unsustainably low rates. The Fed has now embarked on their return journey and we would expect these enthusiastic bond buyers to have a rude awakening as
Fed Funds continue to be methodically increased.


In this Edition

  • Coming or Going?
  • Speed Limit
  • Bond Market Showdown
  • Absence of Context

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

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

18 - 08.03.04
July: A Difficult Stage

17 - 07.01.04
2004 Second Half Outlook

16 - 06.01.04
Big Bad Fed

15 -05.04.04
Rising Rates/ Google IPO

14 -04.01.04
First Quarter 2004

13 - 03.02.04
2004: Encore Performance

12 - 02.03.04
Market Outlook/Cell phones

11 - 12.16.03
Auctions - eBay, US Treasury, IPOs

10- 12.02.03
Recent Economic Data
Market Implications

More Past Issues
can be found in our

Newsletter Archive


Market Highlights

  09/30/04 6/30/04 3/31/04 12/31/03 12/31/02
DJIA US 10080.3 10435.5 10357.7 10453.9 8341.63
S&P 500 US


1140.84 1126.21 1111.92 879.82
Nasdaq US 1896.84 2047.79 1994.22 2003.39 1335.51
EAFE Int'l Equity 1318.03 1327.97 1337.07 1288.77 952.65
5 Yr Treasury 3.408 3.818 2.89 3.231 2.74
5 Yr AAA Muni 2.61 3.15 2.38 2.45 2.59
10 Yr Treasury 4.163 4.636 3.874 4.225 3.82
10 Yr AAA Muni 3.48 4.02 3.49 3.6 3.72
30 Yr Treasury 4.898 5.166 4.69 5.01 4.77
30 Yr AAA Muni 4.58 4.93 4.51 4.54 4.69
EUR Currency 1.2336 1.2157 1.2227 1.2612 1.0488
JPY Currency 110.82 108.88


106.92 118.69
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