Farrell: 3 Things To Mute Recovery

Tuesday was a real yawner, with volume near yearly lows and seemingly nothing going on.

But beyond the widely expected repayment of TARP by a bunch of banks, there were some other things going on.

The three-year Treasury auction was well oversubscribed and saw a lot of foreign buying.The bid to cover was a healthy 2.82 times against an average of the last five auctions seeing a cover of 2.44 times. The "indirect participation" was almost 44%, and that's where the foreign money would be.

All well and good, but we expected the shorter-maturity auctions to do well. More stressful will be Wednesday's 10-year auction.

The economy is showing signs of recovery, and any politician worth anything would claim credit. But the economy has done it on its own, and the Administration's claims of success are a little short as to timing.

As of the beginning of May, about $100 billion of the $787 billion stimulus package was available, and as of this week some $80 billion-odd has been taken down: Hardly enough to have made a difference.

The Administration has pledged to hit the accelerator and has announced 10 projects to try to


spend 70% of the money by the end of the next fiscal year. It can't hurt but spread over time; in a $14 trillion dollar economy, it all moves the needle but a touch.

Every bit helps, of course.

There was word going around that the Fed is backing away from its plan to ask Congress for permission to sell its own bonds. Fed Chief Ben Bernanke has talked about wanting to do this a couple of times. The effort would be to sell bonds into the market to take liquidity out when Ben feels that things are moving along and the velocity of money has normalized. Inflation could be the result of not draining money at the right time.

Selling bonds into the marketplace is less visible than raising the Fed Funds rate probably at a time that would make Congress uncomfortable. There are other things that could be done (e.g., raise the interest rate on free reserves to discourage lending), but I really liked the idea Ben had. I am discouraged he is backing away. The fight with Congress, I guess, is not winnable at this time.

This is not good news to me. Also, Ben faces a big issue this summer.

At the rate of spending, he will go through the $300 billion pledged to buy Treasuries by about August. Does he re-up? If so, what signal regarding inflation fears does that send to the market? If he passes and lets rates find their own level, does that represent a risk as to where rates might go? Not an easy call.

My own feeling is that rates are finding their own level despite the attempts by the Fed to keep them down. The 10-year is approaching 4% and correspondingly the 30-year mortgage has backed up to a point that refinancings are dying.

He will probably re-up but slow the pace of buying to less than the $7.5 billion per week he has been averaging so far. Better to have a seat at the table with a big checkbook than to be looking in from the outside.

Oil touched $70 on Tuesday, and the price of gasoline is sure to follow. The national average for gas last month was $2.62, up $1.00 this year. Every penny at the pump is about $1.3 billion out of consumers pocketbooks on an annual basis. So $1.00 at the pump represents a $130 billion annual hit to the consumer.

With mortgage rates rising and thereby blocking refi's, savings going up, and rising gas prices, whatever recovery we get will be muted, and the thought the Fed would raise rates now doesn't compute.