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Monday July 11, 2005 - 11:21:59 GMT
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Yield curve questions


“If the Street's professional opinion-givers are to be believed -- and that kind of credulity can be extremely dangerous to your financial health -- the impetus for the final session's advance was the release of the June employment report. Unless the Bureau of Labor Statistics put out two different reports, that interpretation frankly mystifies us: The June jobs report we read was far from bright.”

Alan Abelson, Barron’s

FX Trading

There is still much talk about whether the yield curve (above) is telling us something or not. Is the tightening spread between short- and long-term interest rates a harbinger of slowdown on the horizon—an assumption normally discerned from a similar shaped curve? Or is it different—again—this time?

As Mr. Abelson observers, in his Quotable above, it didn’t seem the employment report was quite what is was cracked up to be. In fact, employment growth overall is still lagging in this recovery, but we don’t seem to notice much because it’s a heck of a lot better here than most other places. But saying that, doesn’t answer the question about the potential for a pending slowdown.

A couple of points to support the “yield curve IS telling us a slowdown is in the cards” view:

1) Job and wage growth are lagging badly in this recovery: “Not only has private sector job growth fallen nearly 10 percentage points short of the typical recovery path, but fully 42 months into this recovery, the inflation-adjusted hourly wage rate is fractionally below the level prevailing at the trough of the last recession in November 2001,” write Stephen Roach of Morgan Stanley. [our emphasis]

2) Conundrum solved, as Barron’s summarizes Houisinton’s reasons why they have been bullish on bonds for a long time—well ahead of the curve: “Key to the Hoisington strategy was his and economist partner Lacy Hunt's apercu that the game had changed dramatically with the fall of both the Bamboo and Iron Curtains and the ‘integration’ (Greenspan's favorite word) of India into the global economy. Hence, inflation and inflationary expectations were likely to wither over a number of years as huge new reservoirs of productive capacity and cheap labor were unleashed.

“As a result, Big Business and Big Labor, the oligopolistic bulwarks of the post-World War II affluent society, would lose their pricing power. Mass migrations of rural workers to higher-wage areas like China's coastal cities, South American and Indian urban centers and across the Mexican border to El Norte would continue unabated for years, putting a lid on labor costs. And the economies of scale now possible in today's vastly larger global trading markets would only bolster the disinflationary forces at work.”

OK…is there a point here for FX traders? Maybe! We get a look at US consumer and producer prices at the end of the week. We get a look at bond market price action before and after the news. It could tell us much about how the market will perceive the Fed going forward. Low inflation news would quickly shift perceptions back away from an aggressive Fed view to a kinder gentler perception—that could be a catalyst of a dollar correction that seems technically overdue.

But, if we get roaring inflation news, we are back to the same game: The Fed takes away more punch and we keep asking, is the yield curve really telling us anything? Or maybe bonds finally turn tail and run—and we no longer worry about the solutions for the conundrum.

Jack Crooks
Black Swan Capital


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