On expected recovery, inflation threat, bond market, interest rates
Business has made considerable progress in recent months in controlling inventories, and is now poised to increase production. A number of industries will begin recalling workers during the next few months. The best example is the automobile industry, which reduced stocks sharply during the fourth quarter of 1982 and is now raising output plans. The reduction in inventories is a major reason for the tentative estimate that real GNP (gross national product) declined at a 2.2 percent rate in the last quarter. However, the turnaround in inventories means the current quarter is likely to exceed general expectations of a low 1 to 2 percent growth rate. Additional support for consumer income is implied by a high level of tax refunds expected in April, and the 10 percent tax cut effective in July.
- T. Rowe Price Associates Inc., Baltimore
The decline in inflation does not in itself promise to produce a [world] recovery, but it does provide scope for policy to be shifted in an expansionary direction so as to promote recovery. Such a policy adjustment should be undertaken promptly. It should be internationally coordinated, for there is little prospect that an adequate global stimulus could result from a series of isolated national actions. In addition, there is considerable risk that isolated ''locomotives'' might find themselves subject to excessive depreciation that rekindles inflation. In particular, neither can the world simply wait for the United States, nor can the United States be certain of achieving adequate recovery on its own.
- Institute for International Economics, Washington
The fixed-income [bond] markets will be affected by a crosscurrent of forces and events in 1983 that will have divergent consequences for interest rates. The markets will benefit from a subnormal economic recovery that should generate real economic growth of only 2 percent year over year and an inflation rate of 5 percent, or perhaps less as measured by the GNP deflator. Heightened liquidity preferences may also result periodically if the international debt problem becomes more acute, or if the recovery in corporate profits is less than generally expected and thus significantly weakens the confidence of creditors who have loaned funds to marginal businesses. The huge borrowing requirements of the federal government are likely to cause market apprehension and price setbacks if it is perceived that economic expansion is again taking hold.
- Salomon Brothers Inc., New York
Although current trends would suggest that ''inflation is a dead issue,'' as [Fed chairman] Paul Volcker put it, a renewal of inflationary tendencies is now unavoidable should the world's economy start to recover. First, as demand starts to improve, there will be widespread increases in prices from raw materials through to finished goods. Second, there has been a serious loss of effective manufacturing capacity since 1979, particularly in the US, so that recovery may well bump up against cost-effective capacity limits far sooner than the conventional utilization ratios would suggest. Third, by itself, monetary policy does not kill inflationary psychology as has been the Canadian experience. Fourth, of all the causes of inflation, that of monetizing national deficits leads to unlimited continuous inflation. And fifth, should there be a Middle East crisis, oil prices could rise suddenly, significantly, after which there would likely be a long-term decline.
- Sinclair Securities Company, New York
As long as economic lethargy continues, the Federal Reserve Board will be under pressure to keep lower interest rates until it stimulates a recovery. Declining interest rates have been the fuel behind this rally, and as long as rates keep moving down, the market is on relatively safe ground. Furthermore, once the recovery fully materializes, the stock market should benefit from expectations of rising corporate profits and reduced risk of a major corporate disaster.
Thus, it is only for the much longer term - 1984 and beyond - that the risk is substantial. As economic growth resumes, interest rates will nudge higher as private credit demands compete with the government's astronomical borrowing needs. (Two back-to-back $200 billion-plus annual deficits are practically a certainty.) If the Fed attempts to ameliorate an interest-rate rise by adopting easier monetary policies, the ultimate consequences will be a revival of inflation, and that could spell finism to the bull market. For now, though, conditions remain conducive to rising stock prices, and the safest policy is to be fully invested in a market where most of the surprises are on the upside.
- Institute for Econometric Research, Fort Lauderdale, Fla.