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INTEREST
RATE WATCHPrepared
by
R. J. O'Brien & Associates,
Inc.
GovernmentalPresident Clinton
has to be extremely happy, for the U.S. federal government
registered a lower than expected budget deficit of $34.6 billion in
August, a reduction of 17% from the same time a year ago. For the
first eleven months of this fiscal year, the deficit is $71.3
billion, down 50% from last year's level. It now looks like we'll
have a $35 billion deficit for all of 1997.
The most interesting
aspect of the monthly Treasury statement was the numbers for
individual income tax receipts. The main reason the U.S. budget
deficit has fallen at a much faster rate than anyone has expected
has been the substantial increase in individual income tax
receipts. We have fixated on that increase as support for our
theory that the U.S. economy was not about to slow down any time
soon. Higher individual tax receipts have to mean higher consumer
income, which should result in a higher level of economic activity
and higher short term interest rates.
These numbers are extremely
volatile on a monthly basis, so we try to smooth things out for our
own analysis by taking a three month average and comparing it to a
year ago. Receipts are a very healthy 10% over year ago levels.
However, the trend is down, and August was the first month since
February where individual receipts were lower than the same month
a year ago. Given the strong evidence everywhere that a strong
economy presently exists, it's too early to conclude from one
month's figures that the consumer spending will be slowing down,
but it is something we'll be watching very
carefully.
FundamentalIt is a testament
to the bullishness of today's marketplace that futures finished
higher this week in the face of extremely strong economic
figures.
Durable goods were up a whopping 2.7% for the month, and
like most of released government reports, the previous months
figures were revised higher. Although some bulls tried to discount
the rise in new orders by pointing to the record rise in orders for
electronic equipment, the overall figures were very strong.
Compared to last year, new orders are up 11.9%, shipments are up
6.9% and unfilled orders are up 4.5%.
Sales of existing
single-family homes reached a record-breaking high point in August.
The seasonally adjusted annual rate of home re-sales rose 3.3
percent from July's rate of 4.18 million units to the August rate
of 4.32 million units, which is the strongest pace recorded since
National Association of Realtors began tracking home sales in 1968.
As a result of this “really hot” demand, there were 2.03
million existing homes available for sale in August, which
represents a 5.6-month supply at the current sales pace–that's
the lowest this year. In addition, home prices climbed, with median
and average prices up 4.25% and 6.14%, respectively, over year ago
levels. (It's not inflation if you own your own home!)
New claims
for unemployment insurance fell for the fourth time in five weeks,
reaching a seven week low and are running at a level 5.37% below
last year. The total number of jobless receiving benefits have
fallen 127,000 in the past two weeks and are at the lowest level
since September 1989.
GlobalIf there is anything
more bullish for the credit market than the declining budget
deficit and the relative decrease in the supply of government debt,
it's the strong dollar. Indeed, in the past three weeks, Treasury
Secretary Rubin has time and time again stressed the importance of
the strong dollar. (You almost get a feeling that he is a little
worried).
Two weeks ago, we pointed out that the U.S. Dollar and
many of the major world stock markets had topped on the same day
(August 6). We speculated that perhaps a “sea change” in
investor opinion was occurring.
We don't see a good fundamental
reason for a weaker dollar, unless it is that the dollar has gotten
too strong, and it's time for it to swing back into balance. In our
opinion, the Germans are trying to talk a bottom in the
Deutschemark. They hint at a rate increase, but it really doesn't
make sense to put in place a more restrictive monetary policy on
top of an already tight fiscal policy–not, at least, when you
have a 11% unemployment rate. The Japanese are also caught in a
tight squeeze. America won't tolerate a weak yen any more, but
their economy is too weak to tighten monetarily, and their attempt
to impose some fiscal discipline has led to a sharp pullback in
economic growth. So at the moment, our economy remains supreme, and
that should mean a stronger dollar. However, our dollar has
recently weakened, and that's not good for our credit markets. A
weaker dollar could lead to smaller foreign purchases of U.S. debt
instruments, and could lead to a sudden resurgence of inflation in
an economy that is strong, with capacity restraints.
RJO
Conclusion: We have been correct in our analysis that the U.S.
economy would remain strong, but incorrect in our prediction that
it would lead to higher short-term interest rates. A weaker dollar,
if it continues, might be all that is needed to push the Fed to
tighten.
September 26, 1997
R. J. O'Brien & Associates,
Inc. 555 West Jackson Blvd., Ste. 700, Chicago,
Illinois
Copyright 1997, by Consensus Inc. All American and Pan American
rights Reserved. editor@consensus-inc.com
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