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INTEREST RATE WATCH
Prepared by
R.J. O'Brien & Associates, Inc.
Fundamental
The U.S. Treasury Department released its latest numbers on the U.S. budget this week, and it was all good news for the U.S. economy. Although both the Clinton Administration and the Congressional Budget Office are predicting a budget deficit over twice the size of last year's low $22.3 billion, it hasn't started out that way. October's budget deficit totaled $35.6 billion, which is $4.2 billion better than last October's number. We are moving towards a balanced budget before schedule. In the last twelve months, the deficit has totaled a paltry $18.1 billion. The significant increase in individual income-tax receipts has been chiefly responsible for the move towards a balanced budget, and last month was no different. Individual tax receipts were up 13.2% over last October.
This increase in tax receipts is a two-edge sword for the credit markets. The reduction in the budget deficit has meant a reduced supply of treasuries on the market, and is perhaps the biggest bull factor supporting the bond market. On the other hand, individual tax receipts are the hardest possible evidence of consumer income levels. This continued, sharp increase in tax receipts means that the government measures of consumer income growth are woefully understated. The strong income growth of the American consumer is a powerful reason that vigorous U.S. economic growth should continue well into next year.
By The Way
There were two interesting stories in the local Chicago newspapers this week. In the first, the Tribune reported that the Chicago hotel vacancy rate was at its lowest level in well over ten years, and that as a result, hotel room prices are up 10% over last year's levels. From personal experience we at RJO can also say that the office vacancy rate in the downtown business sector is extremely low, and that the discount rents and the buildout dollars that were freely offered just a few years ago are no longer existent.
In the second story, the Suntimes warned readers to be prepared for long lines at stores during the Christmas shopping season. It seems that retail stores are having trouble finding workers–even after offering prospective workers 20% pay hikes and bigger discounts on in-house merchandise. Aside from the obvious implications concerning wage inflation in the important service sector, we can't help but (cynically) wonder: Given Mr. Greenspan's well-known thoughts on the real rate of inflation, and the Boskin report which stated the current CPI does not reflect the big improvements in quality of goods and services, do you suppose the statisticians at the BLS will now act to raise the December CPI due to a marked deterioration in services provided by the retail sector?
Global
This week the market heard two comments from top officials in Japan; the implications could have serious ramifications for our economy. In the first, the Bank of Japan asked the Federal Reserve Bank of New York to assist Japanese banks in raising dollar funds. The request was based on a pact the BOJ has with the NY Fed, by which the Fed will provide dollar funds to cash-strapped Japanese commercial banks in the event of a financial crisis in Japan. We have to ask: if the Fed is forced to provide liquidity for Japan, what are the inflationary implications? U.S. monetary growth is already very strong, with M2 and M3 growing at 7.2% and 10.2% rates during the past three months. Providing more liquidity for Japan, Korea and others could inflate monetary growth from these high levels, which would, at the very least, promote strong U.S. economic growth, and increase the probability of a higher inflation rate.
Comments from the Japanese Ministry of Finance had a more immediate effect on the marketplace. The MOF stated that it would use its foreign exchange reserves if Japanese banks faced difficulties raising funds. This raised the prospect of large sales of U.S. treasuries, and helped keep the credit markets on the defensive. On Friday, the Fed shed some light on the question when it released its latest numbers. As of Wednesday, November 26,1997, the face amount of marketable U.S. government securities held in custody by the Federal Reserve Banks for foreign official and international accounts was $617.808 billion, a decline of $7.963 billion for the week. It's important to understand that this liquidation by foreigners is not new. Foreign holdings are down $35.5 billion or 5.43% from their peak in April 97, yet the credit markets are trading near their peaks. It is apparent that domestic demand is buoying this market. The latest numbers from stock mutual funds reveal a decline in mutual stock fund flows. The increase in stock market volatility is having a significant effect; more investors are now seeking the relative safety of the money market and bond mutual funds.
The Conference Board's Consumer Confidence Index increased 4.9 points in November, and is slightly below a 28-year high. The ABC/Money Magazine poll agrees–its weekly consumer sentiment index has jumped to a 7- week high. This lofty level of consumer confidence should not be surprising, for consumer income and wealth is surging. This week's economic reports were reflective of that reality.
Sales of existing single-family homes rose again in October breaching an unprecedented monthly sales rate. It was the strongest pace recorded since National Association of Realtors began tracking home sales in 1968. Average and median home prices are a whopping 6.43% and 7.45% higher than year ago levels. We can expect more of this in the future; the 30-year fixed mortgage rate is the lowest since February 1996.
New orders for durable goods fell 0.3% in October, but September new orders were revised higher, Compared to a year ago, shipments are up 8.6%. new orders are up 6.0% and unfilled orders are up 3.0%.
New claims for state unemployment insurance benefits plunged by 31,000, the four-week average is 6.64% below last year. The total number receiving benefits also declined by 31,000: the four-week average is 9.97% below last year.
Finally, early news reports show strong Christmas sales–another indication of strong U.S. economic growth.
November 29, 1997R.J. O'Brien & Associates, Inc.
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