- 2001: Volume 10, No. 1 What's Hot and What's Not: U.S. Economy Moves the Markets

Concern that the U.S. economy may be headed for a recession triggered big moves in many financial markets. The stock market fell sharply, followed by a steep decline in the U.S. dollar and strong rallies in interest rate futures. The energy markets stayed hot; the petroleum complex fell sharply while natural gas went in the other direction—jumping to a succession of record highs. The other big movers were the Japanese yen and live cattle.

Stock Market
After spending most of last year in a broad trading range, the stock market embarked on a sustained downtrend in September in response to deteriorating corporate earnings and growing concerns of a weaker, possibly recessionary, U.S. economy this year. However, a surprisingly large Fed rate cut in early January stabilized the Dow. Since then Fed officials have downplayed the chance of a recession and emphasized the outlook for an improving economy later this year. And even though it’s too early to tell whether the economy has turned the corner, the Dow may recover due to improving investor and consumer sentiment.

U.S. Dollar
The dollar followed the stock market lower, topping in early December in reaction to U.S. economic concerns and anticipation of a Fed rate cut. The Fed’s aggressive 50 basis point easing move in early January indicated the Fed was serious about turning the economy around. However, since the European economy is likely to outperform the U.S. over the first half of the year, and further U.S. rate cuts are expected which would keep interest rate differentials in favor of the euro, the dollar is likely to stay in a major downtrend.

Japanese Yen
The yen moved steadily lower after breaking down from a trading range in late November on Japanese economic and political concerns. Massive government economic stimulus plans have failed to turn the Japanese economy around, and the vast majority of Japanese voters have little confidence in Prime Minister Mori. On top of that, a series of high profile bankruptcies underscored Japanese economic woes. Japanese officials even commented that a weak yen is no big deal, implying Japan has reverted to exporting its way out of the economic slump. Because of that, further yen declines are likely.

Interest Rate Futures
Treasuries and Eurodollars staged strong rallies late last year on recession concerns and in anticipation of a Fed rate cut, then pulled back in reaction to the Fed’s aggressive 50 basis point early-January rate cut on ideas the Fed was serious about turning the economy around. In addition, Fed officials downplayed the chance of a recession and emphasized the outlook for an economic recovery later this year. And even though the Fed is expected to cut rates another 25 to 50 basis points over the next six months, interest rate futures have probably established a top since investors appear to believe the upbeat economic assessments.

Petroleum Complex
Crude, unleaded and heating oil fell sharply in December on talk of a global surplus, then recovered about half of the loss in early January when U.S. supplies failed to rise significantly. Price strength was also tied to anticipation of a 1.5 million barrel cut in OPEC crude output at the January 17 OPEC meeting. However, even with the OPEC cut in output, it’s doubtful prices will embark on another major bull phase since heating oil demand is likely to remain down due to warmer weather, and global supplies are likely to eventually arrive in the U.S.

Natural Gas
Due to tight supplies, natural gas prices exploded in response to strong heating demand from frigid temperatures across most of the U.S. in December, then backtracked when warmer weather arrived in January. However, since it will be awhile before natural gas production rises significantly in response to high prices, supplies are likely to remain tight all year setting the stage for further price spikes if more cold weather arrives this winter or hotter than normal temperatures occur this summer.

Live Cattle
Cattle prices began to rise last fall in anticipation of tighter supplies early this year due to a drop in placements on feed. The up move accelerated when retail beef demand stayed at a much stronger than expected level, partly on improved U.S. beef exports due to mad cow disease in Europe. Finally, prices spiked sharply higher when a series of winter storms and cold weather in the panhandle region stressed cattle resulting in weight loss and lower beef production. However, even though beef supplies will be down, it’s a good bet that demand will also tail off since the slower economy and sky high heating bills are likely to cut consumer spending and demand for beef, which has gotten very expensive. Because of that, this market is probably near a top.