On the one hand...

Northwestern Financial Review, Jul 1-Jul 14, 2005 by Bengtson, Tom

By the time you read this, the Federal Reserve is supposed to have raised the Fed Funds rate to 3.25 percent. As I write this column, the 10-year Treasury bond is paying 4.06 percent. As the two rates close in on one another, the anxiety level over the strength of the economy increases.

The Fed's latest Beige Book is optimistic. Summarized on the National News page of this edition, the report said business activity continued to expand from mid-April through May. But a lot of the comments I have heard in the last few weeks suggest the economy may be slowing.

Edmond Seifried, an economist teaching bankers at the Stonier School in mid-June, explained the perilous combination of high oil prices and rising short-term interest rates. He called it a "perfect storm" that has foretold every recession since 1971. Seifried recently adjusted his Fed Funds prediction for year-end to 3.5 to 3.75 percent, down from the 4.0 percent that nearly all economists had been targeting. Seifried's thought is that the Fed won't want to go to 4.0 percent with the 10-year bond basically at that same number. An inverted yield curve almost always foreshadows an economic slowdown.

The long end of the yield curve is more interesting to me than the short end. Why is it so low? We can get mad at the Chinese for increasing the demand for oil to the point of driving gasoline prices well past the $2 per gallon mark, but we can't forget that it is the Chinese who are financing a large part of our country's debt. The Chinese appetite for long-term U.S. debt is keeping the 10-year bond rate low. That is keeping mortgage rates low, which in turn has led to a boom in the housing market. As home prices rise, people feel wealthier and they spend more. Average net worth is so much higher today than it was in the early 1970s, that proportionally today's higher gas prices just don't hit the consumer pocket book as hard as they used to. Seifried said that if anything keeps our country from falling into recession, it will be the housing market.

Of course, the Chinese are not the only ones helping us out. The euro, which once was a threat to the dollar, looks pretty weak following Europe's inability to agree on a constitution. And, a global fear of terrorism has raised the demand for U.S. securities as investors flee the Middleeast and other geo-political hot spots.

So will we go inverted on the yield curve? Is the United States headed for recession? Perhaps, but as economists like to say, on the other hand... .

By Tom Bengtson, Publisher