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There's a disconnect between the increase in the price of equities and high-yield debt prices on the one hand, and the declines in Treasury-bond yields and many commodity prices on the other hand. Why the disconnect? Today's three key remaining variables for economic growth — the Bush tax cut, the environment for business investment, and oil prices — have all suffered setbacks in recent days. On Capitol Hill this week, the Senate Finance Committee's apparent decision to move toward a dollar cap for the dividend exclusion is a severe setback for the value of the tax cut. A dollar cap would eliminate any stock market or economic growth value for this portion of the tax cut (though the income-tax cut looks intact and has value). If the dollar cap passes the Senate, it will be hard for the House-Senate conference to correct it. Over at the Federal Reserve, a deflation risk (despite the weaker dollar) was highlighted during the FOMC's policy meeting on Tuesday. The day after, the Wall Street Journal headline read "In a Shift, Fed Signals Concern Over Deflation," while the Financial Times headline read "Fed Holds Rates But Warns of Inflation Risk." This confusion discourages investment. It adds to the year-long string of reasons for risk aversion. These have included accounting turmoil, the oil-price spike, and the Iraq uncertainty. Now we have the Fed's confusing view of the economic picture. Businesses, meanwhile, might sensibly wait to see if more interest-rate cuts are forthcoming at the next FOMC meeting, or if the feared deflation materializes. Then there's oil. The barrel price has stalled above $26 with oil futures still elevated. This is a negatives for the global economy and a statement of no-confidence in the ability of the U.S. to break or ignore the U.N. sanctions on Iraq. On a global level, you can add in concerns over a negative impact of a strong euro on European corporate earnings, as well as growing worries over China and SARS. The platform for a constructive, piece-by-piece reflation is still intact, in the form of a non-deflationary value for the dollar and negative real interest rates. But unless the tax-cut, oil, and business stories improve, confidence in the economy and the markets will not improve either. A little policy follow-through in Washington would help.
— Mr. Malpass is the Chief Global Economist for Bear Stearns. |
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rising stock market usually signals an economic acceleration, but
other markets are sending out loud, conflicting signals. 
