Financial Watch

Signs are mounting among Japanese monetary authorities that the nation is moving ever closer to abandoning its long standing policy of near zero interest rates. Economic growth of 5.5% in the fourth quarter of 2005 and an unemployment rate hovering near 4% is once again showing clear signs the Japanese economy is once again regaining the luster it received during its incredible boom during the 1980’s. Japan’s economy is still far from reaching the robust performance it enjoyed during its best years where stock and real estate prices rose astronomically, but it is now clearly on solid footing. Worries over deflating are abating as consumers increasingly open up their pocket books. Also, the Asian nation is strongly benefiting from the emergence of China into the global economy. In the last couple years strong export growth to China has helped the Japanese economy land on its feet and China’s emergence should continue to fuel growth across Asia for many years to come.

Economists for the most part believe the Federal Reserve will raise interest rates two more times before pausing. Of course, this is subject to change depending on economic data during the coming months. In Ben Bernanke’s first public appearance since taking over the reins from Alan Greenspan, he reiterated his predecessor’s belief that the economy was expanding at a steady pace. His comments held few surprises. Most notable from his testimony last week is a lack of true concern about future inflation. Bernanke mentioned the fact high energy prices during 2005 had helped to fuel concerns over inflation. However, Bernanke also stressed that our economy was less susceptible to rising energy costs than was the case back in the 1970’s. The new Fed chief’s upbeat assessment of the economy helped to give a modest boost to stocks last week, but his neutral commentary about future interest rates helped to restrain gains.

The week after Christmas is typically a slow one where many Wall Street traders stay at home enjoying an extended Christmas holiday. Early predictions of it being a slow week on Wall Street were jolted this morning when for a few brief moments the yield between the U.S. two and ten years notes inverted. An inverted yield curve usually is a leading indicator of an economic recession. In fact every time in recent memory that the yield curve has inverted a recession has followed. The inverted yield curve, along with the lack of buyers, lead to a strong sell-off in stocks today. Financial Watch believes the sell-off reflects negative sentiment presently in the market. The U.S. economy seems poised to turn in another decent year next year and any concerns about a recession are overblown. Alan Greenspan dismissed concerns over an inverted yield curve several weeks back and we believe today’s inversion will not impact his decision to raise interest rates another quarter point at January’s meeting.

Last week President Bush announced Ben Bernanke would replace Alan Greenspan as Chairman of the Federal Reserve Bank next January. Greenspan leaves behind a strong legacy. He will most be remembered for leading the nation’s longest economic expansion during the 1990’s and for aggressively reinvigorating growth following the dot-com collapse. Greenspan deserves large credit for his management following the collapse of Long Term Capital Management and the 1987 stock market crash. In both instances quick action to provide increased liquidity to the financial markets prevented these crisis from inflicting serious damage on the U.S. economy.

On Friday the Department of Labor announced a surprising 274,000 jobs were created during April. Despite the strong jobs report the stock market showed just modest gains as concerns over a soft patch gave way to concerns about inflation. The strong report also erased any doubt whether the Federal Reserve would raise interest rates during its next meeting in June. This past week, the Federal Reserve pushed interest rates up another 25 basis points to 3% and maintained its pledge to raise interest rates at a measured pace.

Economic Imbalances of the United States can explain why long term interest rates have moved downward despite the Federal Reserve’s rate hikes

The end of the Spring brought an end to the Federal Reverse’s view interest rates need to positioned in a way of stimulating the economy. For most of the past few years interest rates consistently moved downward as the Federal Reserve launched an ambitious plan to prevent deflation and bring a reversal to a stagnant economy. Low interest rates helped to keep the U.S. economy afloat while the excesses of the 1990’s worked their way off. The United State economic rally last Winter brought a dramatic increase in the level of economic growth, but at the same time an unwelcome spike in inflation fueled primarily by rising commodity prices. Strong economic growth and signs of inflation convinced Alan Greenspan and Co., interest rates should be raised to reflect an economy on solid footing.