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Fewer job losses than expected, at least one Fed official hinting at tighter Fed policy, and a return to the initial policy aims from the Obama administration have put financial markets back in defensive mode.
Casual investors will awaken this Monday morning to U.S. Ten Year note yields that are closer to 4% than they were when last week ended, as a combination of factors is starting to come together in what could be a very negative situation.
Rising U.S. government debt was seen as necessary when the global economy was falling off a cliff. But a less weak than expected employment report, where less than 400,000 job losses were registered, compared with estimates for over 550,000 by some economists, may have changed the landscape. Here's what's at stake. There are still trillions of unspent stimulus dollars that are sitting in a federal vault somewhere waiting to be unleashed. And the Obama administration, after being quiet about raising taxes on "wealthy" Americans to fund health care, has started to beat the drums loudly again.
The result was predictable. The bond market has started to tank, as it fears that the unspent stimulus will not be rescinded, even if perhaps it should be. And that tax policy may backfire leading to stagflation, where the economy is weak but inflation is on the rise because there is too much money in circulation that is chasing too few goods.
In this case, much of the too few goods available could be in the form of, houses, automobiles, and even everyday items such as food. As GM and Chrysler have gone into bankruptcy, there is no way to estimate what kind of production will be forthcoming, or what kind of vehicles will be manufactured. There is little data from which to project the demand for "green" cars and trucks. And at this point, other than so called "smart" cars, which are motorcycles with roofs, the prospects are not all that appealing to U.S. drivers used to roomier cars that can haul large amounts of cargo, such as groceries, sports equipment, and even work tools.
With farmland being taken off the planting cycle by farmers, food prices are also on the rise. Gasoline prices have been rising, and supply has been cut back by refiners as OPEC has cut production.
In other words, as would be predictable under the tenets of Chaos Theory, government policy is leading to unintended consequences, as dark room politics has failed to see the whole picture. According to AP: "big government spending programs are turning out to have the opposite effect" of what was intended as "rates for mortgages and U.S. Treasury debt are now marching higher as nervous bond investors fret about a resurgence of inflation."
So when it comes to housing, the centerpiece of the current crisis: "Kick-starting the economy requires higher spending, but rising rates mean fewer Americans will be able to refinance their home loans. And some potential buyers will be shut out of the market by higher monthly payments they won't be able to afford."
And that means that any kind of economic improvement could stall as mortgage rates reach a point where refinancing is no longer profitable, and even the moderate number of new home loans begins to wane. More important is the fact that the Federal Reserve is starting to note that high budget deficits for the U.S. over extended periods of time could be detrimental. Fed Chairman Bernanke told Congress last week that the U.S. "as a nation, begin planning now for the restoration of fiscal balance.
Chart Courtesy of StockCharts.com
The U.S. Ten Year note (TNX) opens U.S. trading with yields above 3.8%. We are currently short bonds. See our bond timing section for details.
Conclusion
After 18 months of official recession, the U.S. may be near or may have already hit that proverbial inflection point where the economy has gathered enough momentum that further stimulus, from fiscal or monetary policy is not needed.
To be sure, one better than expected employment report is no guarantee that rosier times are ahead. The unemployment rate continued to rise and may hit 10% or higher before things begin to improve more substantially.
But markets tend to look six to twelve months ahead. And the bond market is clearly spooked by what it sees, runaway government spending, radical shifts in tax policy, and tinkering with the U.S. health care system, a major portion of the U.S. economy and a large contributor to GDP.
The fact that foreign bond holders, especially China, are showing increasing concern, and that there is now regular talk from Russia, China, and others, about replacing the U.S. dollar as the world's reserve currency is also of concern.
And for stock traders, the fact that the bullish five days at the start of June have passed, as tensions rise with all these other factors, well, let's just see if the S & P 500 can close the week above 900.
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