FauxPolitik

Tuesday, April 20, 2004

You and your hobby horse: Well, let's look at the indicators. Freddie Mac shows an up-tick in lending rates of about a half a point in the last month alone (from roughly 5.4 to 5.9). Treasuries are up the same amount in roughly the same time frame. The CPI is on the rise and employment continues to improve, oh and retail sales are up. That all points to moving the bar upward on short-term rates by the Fed.

Interestingly, inflation can be a self-fulfilling prophecy. Lenders tend to raise their rates when they think that inflation is on the come. This is known as the "Fisher effect" and an article published just yesterday explains it fairly well:
This is because lenders demand compensation for the fact that the future interest and principal they receive will not be worth as much as the money they lend, in terms of the goods and services it would purchase.
So, I see a raise-hike as an inevitability, for me the question is really how many times will the Fed raise it? Some are saying a one-time raise of a half or a full point will be okay and not cause much shrinkage. Indeed, history suggests that the market will continue to expand after an initial, mild hike. However, if we see three or four jumps throughout the year, then you may see a mad rush out of equities.

The crystal ball question is whether we are in a long-term expansion phase, or just a hiccup, in what is otherwise a flat period. If I had to give a prediction, I would say to watch the housing market. There is no question that mortgage applications are on their way down, but again, this is in comparison to a huge boom. If the bubble bursts, I'd wager the recovery ends. If people lose faith in their ability to fix their expenditures through re-financing, or in their ability to be flexible and move, you may see a return to savings and therefore less spending, which forces companies to get tight, sell less, earn less, and their bankers get nervous. Fun, eh?

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