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Interest Rates Move Lower on Weak Economic Data

The Institute for Supply Management’s factory index was expected to come in at 52.1 following last months reading of 53.3, but the index declined further than expected to 51.4. This was the sixth consecutive monthly decline for the ISM Manufacturing Index, but the stock market bulls are reading the number as positive since anything above 50 indicates growth, albeit at a slower rate. Bond prices are moving higher on economic weakness and stock prices are also moving higher because the ISM data wasn’t as bad as some traders had expected. Stocks are also getting a boost from comments made by Richard Fisher, the new head of the Dallas Federal Reserve Bank.

According to a Reuter’s article, Dallas Fed President Richard Fisher said, “‘I think we’ve room to tighten a little bit further’, but using a baseball analogy, added that the U.S. central bank is in the eighth inning of its tightening cycle and entering the ninth, and usually final, inning this month.” This statement from the Fed is the best indicator so far that the cycle of rate increases is coming to an end for now. Mr. Fisher also noted that the Fed’s job with interest rates is to keep inflation at bay and to maintain economic growth. With all the signs of economic weakness, the Feds need to be certain they don’t raise rates far enough to choke off the economy. One of the big indicators to watch on Friday is the employment report for May. Today we got a possible head’s-up for a weak report to come on Friday. Contained within the ISM manufacturing data, the ISM employment index fell to 48.8% from 52.3%. This is the first time the employment index has dropped below 50% in the last 18 months…signs of further weakness ahead.

The economic weakness is being heard from all parts of the globe, not just here in the U.S. as the battle cry goes out for central banks to stop raising interest rates…in some cases central banks may even cut interest rates lower. The following lead sentences from four of today’s articles will give you a flavor of the global stance on economic growth and interest rates:

“The European Commission cut its second- quarter growth forecast for the dozen-nation euro region as manufacturing shrank and German retail sales dropped, increasing pressure on the European Central Bank to lower interest rates.”

“South Korean exports grew less than expected in May, manufacturers' confidence slumped and consumer prices unexpectedly fell, raising speculation a flagging economic recovery may prompt the central bank to cut interest rates.”

“Australia's economy grew less than expected in the first quarter as business investment shrank and farm output stalled, reinforcing expectations the central bank has finished raising interest rates this year.”

“U.K. manufacturing shrank at the fastest pace in more than two years in May, an industry report showed, deepening concern about a recession in the industry and fueling pressure on the Bank of England to cut interest rates.”

The soft stance on interest rates from overseas and from the Fed here at home will help to keep some strength in real estate markets around the country. Construction spending rose 0.5% in April and year over year construction spending is higher by 8.2%. The Office of Federal Housing Enterprise Oversight said housing prices gained 12.5% in the first quarter versus the previous year. Prices rose 21.3% in the Pacific region, 15.0% in the South Atlantic and 13.8% in the Middle Atlantic region. As you can see, home prices are higher, but activity in the mortgage sector is showing signs of fatigue. The Mortgage Bankers Association reported its application index declined 2.8% with the purchase index down by 4.1% and the re-finance index lower by 1.2%. The 30-year fixed rate mortgages fell two basis points to 5.61% and the average one-year ARMS rate fell 12 basis points to 4.09%. If we continue to see money pouring into bonds with further signs of economic weakness, I’ll be ready to grab a 30-year fixed rate at 5%...it could happen with the yield on the ten-year note falling below 4.0% today (see chart).

Stock prices began the day higher with the Dow Industrials up more than 100 points through the middle of the session, but it looks like reality is setting in as we move into the last hour of trading with the Dow holding a 45 point gain. Stock traders were happy to hear that interest rates won’t be going much higher, but the reasons for ongoing low interest rates should not be good for stock prices. A slowing economy implies recessionary pricing for stocks, not a new bull market. By the end of today’s trading the Dow Industrials added 81 points to 10,549 and the NASDAQ Composite gained 19 points to close at 2,087. The bulls are saying we can remove the “rising rates” scenario and just price stocks based on fundamentals and knowing that the economy is growing, just at a slower pace than previously thought. I don’t buy the spin…stock prices should move lower with a slowing economy.

I have found it most difficult to write today as I have been heavily focused on my trades in silver and natural gas. In last weeks Wrap Up I posted charts of the two commodities and gave some of the fundamental reasons for my bullishness. My $7.50 silver calls came in the money today, despite all the strong dollar nonsense in the currency pits. The bullish fundamentals of tight supply along with the COT’s showing the commercials going long was enough force to propel silver higher in the face of a strengthening dollar. When I wrote last Wednesday, July silver closed at $7.13 and today closed at $7.52 after reaching an intra-day high of $7.61.

The technical analysis I showed last week for natural gas is about as basic as it gets. Trendline support was holding above the $6.00 mark and the Relative Strength Index posted an oversold reading below 30. The last two times RSI touched 30, the price moved significantly higher over the ensuing two to four months. Natural gas closed at $6.21 last Thursday and today closed at $6.77, adding 39 cents today alone, and most of that in the last two hours of trading. Energy prices are making huge gains across the board today! Crude closed $2.48 a barrel higher at $54.45 and unleaded gas and heating oil both had big gains with problems at a Shell refinery. Unleaded gas closed 7.5 cents higher at $1.542 and heating oil was higher by almost nine cents a gallon to close at $1.539. Energy gained 5% to 6% across the board, so now we shall see how prices react when the most recent inventory data is released tomorrow. The Energy Department normally announces energy inventories every Wednesday, but the data will be out tomorrow due to the Memorial Day weekend.

The U.S. dollar moved higher once again today with more evidence of weakness in Europe and another no vote for the E.U. Constitution coming from Dutch voters based on the exit polls. The dollar has clearly rallied since the French no vote for the constitution, but in my view commodities could care less. All the fiat paper money games in the world will not harvest any more natural resources from the ground. The world will have only two choices: either move into a global recession to cut back the consumption of resources, or invest and build infrastructure to meet the growing world demands. Based on history, the Fed will try to inflate its way through any potential recession and in the meantime, play catch-up to invest in resource based industries. Just look for the commodities with the most bullish fundamentals where infrastructure is lacking. Today was a very nice pop in natural gas! I’ll take it!!

Have a Great Evening!

Mike Hartman

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