Yesterday we saw good economic numbers. Personal income and personal spending numbers were better, as expected. ISM Manufacturing was impressive. Auto sales were strong, although GM and Ford (NYSE:F) missed expectations. PCE indicates that inflation is in check. The equity markets shrugged off this weekend's attempted bombing in New York City and a massive oil spill in the Gulf of Mexico and gained over 143 points. Things are looking good. However, there is still an area of concern, lending.
Banks are not lending to small businesses and individuals as they had during the last expansion. Now they have these silly things call lending standards. Borrowers have to qualify for low rates or credit at all.
It is not all the banks. Businesses and consumers are deleveraging. The demand for credit is down significantly. The Wall Street Journal reports that many business owners do not want to return to the wild days of over-borrowing. This could moderate growth down the road, once the stimulus is scaled down and eventually removed.
This is not such a sophisticated concept. Stimulus removed should equal more moderate and sustainable levels of growth. Those levels will probably be more modest than to what many Americans have become accustomed. Another phenomenon to which many investors may not be expecting is the small amount of tightening necessary to manage the economy.
The Fed Funds rate may not have to be taken that high to reign in whatever inflation materializes. It is not like there will be much lending to curb. Higher rates would put pressure on public corporations, especially those with lower credit ratings. One hundred basis points of higher borrowing costs can be the difference between good and great earnings for investment grade companies and life and death for junk bond issuers.
I don't think we will see Fed Funds breach 3.50% during the coming tightening cycle (I think I am being generous in my forecast). This means that three-month LIBOR won't be much higher. Developing trends mean that floaters and TIPS should only be used as hedges and not as ways to outperform.