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A YEAR AGO, all you heard was talk of "green shoots." Now, why isn't anybody admitting the grass is showing brown patches?
"Green shoots" were the metaphor for the first, frail signs of recovery from the deep freeze in the economy caused by the credit crisis. In mathematical terms, it was also described as a "second-derivative" change, which meant the rate of decline was slowing.
We can now see the mirror image of what was happened in 2009. The second derivative of the economic expansion is declining; that is, slowing. And to continue the horticultural metaphor, some of those green shoots are withering this summer.
In Wednesday's batch of data, the non-manufacturing purchasing managers' index from the Institute for Supply Management ticked up to 54.3 in July from 53.8 in June, but it remains below its peak in March to May. Anything above 50 denotes expansion, so this decline reflects a slower rate of gain. Meanwhile, the factory ISM PMI has moderated steadily, to 55.5 in July from a peak of 60.4 in April.
Meanwhile, the ADP Employment Report showed continued anemic growth in private payrolls of 42,000 in July, less than half the gain economists were looking for in the Labor Department's report due Friday morning. Combined with the termination of temporary census workers, July non-farm payrolls may show a trivial overall decline, somewhere less than 100,000, which is far less than the margin of measurement error. It also would fall far short of the prediction of Vice President Joe Biden last spring that payrolls would start to score monthly gains of 500,000.
What's remarkable is that the fixed-income and currency markets have taken due note of the signs of economic slowing, bringing down bond yields and the dollar, while the stock market rallies on its merry way. The Dow Jones Industrials have been able to hold onto Monday's 208-point pop through Tuesday and Wednesday's somnolent sessions, putting it within 6% of April's peaks.
In the bond market, however, the two-year Treasury set another record low of 0.53% Tuesday and the benchmark 10-year note remains well under 3%, at 2.95% Wednesday. Meantime, International Business Machines (ticker: IBM) was able to sell three-year notes at just 1%. Such low yields indicate investors' quest for any kind of yield in such as environment.
In the currency market, the dollar is less sought-after as the economy cools and talk heats up about additional Federal Reserve monetary moves to give the economy a boost. As a result, the euro has recovered to $1.32 just in time for tourist season from $1.19 during the tensest days of the European debt crisis last spring.
That this is a case of dollar weakness and not euro strength is evident in the concurrent rise in the Japanese yen. A dollar now only buys 86 yen, down sharply from 95 yen at its peak in early May.
The U.S. Dollar Index, which measures the greenback in terms of six major currencies, also has slid about 9% in that span, to just over 80. That number is worthy of mention only because it represented major support for decades—until it was breached during the financial crisis and talk of the demise of the dollar last year, when it fell as low as 75. Whether the 80 level holds here may be telling.
What's interesting is that much of the rest of the world is seeing precisely the opposite conditions from the U.S.—robust growth with increasing inflationary pressures. But because many emerging economies don't have freely floating exchange rates, they wind up importing the monetary policies of the slow-growing, developed economies, and possibly exacerbate their own problems.
Most of Asia outside of Japan—China, Taiwan, Korea, Thailand, Malaysia and Singapore—have controlled exchange rates. As a result, they have low, U.S.-style interest rates, while their central banks have to buy up dollars to prevent their currencies from appreciating. Unless offset, or "sterilized," by sales of bonds, the central banks become engines of inflation in overheating economies.
Moreover, the inflation problem in emerging economies is exacerbated by rising commodity prices, especially for foodstuffs. Wheat prices are soaring in large part because of Russia's drought. That may add two bits to the price of a loaf of bread for Americans, no big deal; but food prices are much bigger part of the market basket of consumers in emerging economies. Their central banks are sensitive to that inflation and would be inclined to raise interest rates were it not for the pressures they would exert on their currencies' exchange rates.
However the conundrum is resolved, something as seemingly trivial to Americans as an uptick in grain prices may introduce new risk into high-flying emerging stock and bond markets, the darlings of asset-allocators these days.
At the same time, the rise in crude oil prices above the $80 a barrel level is showing up promptly at the gasoline pump. Retail gasoline prices over $3 a gallon are certain to siphon more from the spending power from U.S. consumers' already disinclined to spend on discretionary items.
It is quite puzzling how equity investors see the proverbial glass more than half full while their counterparts in the fixed-income and currency markets see it half empty.
Stock investors can focus on larger, public businesses that have access to credit and can maintain or expand their profit margins by leaning on their smaller suppliers. Moreover, much of the good news in this earnings season comes from banks, which can flow a reduction in loan-loss reserves through their earnings statement. But many companies are generating even greater free cash flow while they keep tight grip on their purses when it comes to expansion. Equity investors expect they will share in that larder.
Currency and bond investors see the larger forces at work in the U.S. economy, namely deflation. The New York Times highlighted on page one Wednesday the growing incidence of outright pay cuts instead of layoffs, something that was assumed to be a relic of a dark, Dickensian past.
The July employment report, due out Friday morning, may take on outsized importance should it be an important influence on next week's meeting of the Federal Open Market Committee. The Fed's policy-setting panel may take steps to expand its balance sheet further in an attempt to provide more support for the economy, if the press leaks are to be believed, if the jobs data disappoint again.
If so, Treasury yields and the dollar can be expected to fall further. Will that benefit large-capitalization stocks, many of which earn the lion's share of their profits abroad? And how do inflationary pressures in Asia figure into U.S. multinationals' earnings outlook?
These questions are unanswerable. You would think such uncertainty would bedevil the stock market. Apparently not, which seems befuddling in itself.
Email: editors@online.barrons.com
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