U.S. ECONOMIC AND
INTEREST-RATE OUTLOOK
Prepared by Merrill Lynch & Co.
International Fixed Income Research
The market is running in place. Treasuries have been moving up and down: rising after Fed Chairman Greenspan made no policy-related statements in his two public appearances, falling after the firmer-than-expected Retail Sales report, rising again on the softer-than-expected CPI and Philadelphia Fed reports, and tumbling after the upward surprises on housing starts and industrial production. Buyers came in on the dips and stayed out on the market pops, keeping yields within tight ranges. The market may well remain in a narrow range as investors remain sidelined, awaiting the data barrage at the end of the month, and Greenspan's October 29 Joint Economic Committee testimony.
There appears to be a split within the FOMC, between those who are comfortable with the idea of keeping policy steady for as long as inflation stays calm, and those who would want to tighten policy as long as demand growth stays strong. Based on recent testimony, Chairman Greenspan would appear to be in the latter camp, arguing that the economy was on an “unsustainable track” and that unless demand slowed markedly, inflation would probably accelerate.
The most recent data appears to provide fodder for both sides. Consumer spending is likely to have risen by a hefty 5.5% to 6% in real terms in the third quarter. Retail sale increases did taper off as the quarter progressed, but hardly a “marked” slowing in demand given the pace of spending for the full quarter. Also, the rise in capacity utilization to a 31- month high adds to the concern about tightening in resource markets.
FOMC members who are waiting for the “smoking gun” of higher inflation have yet to see anything worrisome. Core CPI growth reached a cyclical low, and the aberrational 0.5% pop in the PPI for September at worst suggests that price deflation has ended. A strict reading of Greenspan's testimony suggests that the information in hand is enough to merit a tightening. But things could change between now and the November 12 meeting. For now, the odds of a move are about even. Signs of labor-market tightening in the Employment report could tip the scales toward tightening.
Martin J. Mauro
Fixed Income Strategy
The market was once again given sufficient economic information to satisfy both bearish and bullish opinions this past week. The lack of further price gains can be attributed to data that was perceived to be stronger than expected. However, the market's inability to break to new lows (on a short-term basis) was a function of its strong technical condition, which resulted from a lack of supply in conjunction with the coupon pass.
A more widespread flattening of yield curves could significantly impair the cost of carry trades and relative-value relationships throughout the marketplace. For example, the 35 basis-point spread between two-year Treasuries and Fed Funds would likely trend wider as rising short-term rates abroad became more attractive on a relative-value basis. In summary, a potential shift in supply technicals and a subtle shift in global monetary policy should result in a more significant flattening of the Treasury coupon curve over the near term.
Thomas J. Sowanick
(Reprinted by permission. Copyright © 1997 Merrill Lynch, Pierce, Fenner & Smith Incorporated.)
October 23, 1997Merrill Lynch & Co.
International Fixed Income Research
North Tower, 21st Floor
World Trade Center, New York, New York
THE ALLENDALE ADVISORY REPORT |
STRATEGY FOCUS |
WEEKLY OUTLOOK
ECONOMIC PERSPECTIVE |
FED STEER PRICES GOING NOWHERE FAST
U.S. ECONOMIC AND INTEREST-RATE OUTLOOK
STICKING WITH THE U.S. TREASURY MARKET |
THE TODD MARKET TIMER
CASH AND BONDS-- THE RODNEY DANGERFIELDS OF FINANCIAL ASSETS?
MYERS ON FUTURES |
THE COPPER JOURNAL |
COMMODITY FUTURES FORECAST WEEKLY REPORT
INTEREST RATE WATCH |
NIKKO MARKET COMMENTS
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