Euro continues to drift sideways

The euro continues to drift sideways in the $1.33 to $1.38 trading range.For now, the overall trend is neither up nor down, but "sideways." Euro futures closed on Friday at $1.3568, 1.49 cents above the $1.3419 level of two weeks ago. I strongly suspect that the recent "retreat" was more of a short-term trading phenomenon and not indicative of a longer-term trend per se. I would give the euro bulls and dollar bears a few more shots at $1.37 and $1.38 over the next month before concluding that the euro is likely to weaken for the rest of the year.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, a decent Q2 GDP report in July, and a strong hint of a rate hike in August or the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.38 range as long as there is any superficially bad news to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."]

-- Jack Krupansky

Fed remains likely to stay on course at 5.25% for all of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Most people expect the Fed to be "on hold" for the rest of 2007 and at least Q1 of 2008, but more than a few are once again expecting a cut in Q2 of 2008. On the other hand, that may be more of an insurance hedge rather than an outright bet. Besides, Q2 of 2008 is simply too far in the future for anybody to have high confidence about the economic and inflation outlook.

For now, my overall assessment of Fed monetary policy remains:

My view is that the Fed will keep the Fed funds target rate paused at 5.25% for all of 2007, and probably well into 2008.

There will not be a recession this year, nor even enough of a growth slump to trigger a Fed rate cut.

The Fed will not cut rates in response to the concern about subprime mortgages.

The Fed will not worry about the health of the economy since it is MUCH healthier than the 0.7% Q1 "real" GDP growth rate "estimate" suggests.

I would suggest that there is a 1 in 3 chance that the Fed will hike rates by a quarter-point at either the August or the September FOMC meeting.

I tentatively say "for now" because I remain half-convinced that the Fed may in fact feel the need to make another hike in August or September to 5.50%. To my way of thinking, it all depends on what happens with energy commodities. Prices of oil and gasoline futures are still quite elevated, albeit off their Summer peaks, and this constitutes an ongoing source of inflationary pressure that continues to propagate throughout the economy. If prices of energy commodities resume their decline, the Fed will be able to remain paused for all of 2007. But if energy commodities prices do not continue to fall, the Fed may have little choice but to hike to 5.50% in August or September. If we don't see crude oil consistently below $50 and retail unleaded gasoline consistently under $2.00 by July, expect a Fed hike to 5.50% at the August or September FOMC meeting. Based on economic fundamentals, we should see the prices of energy commodities come back down to Earth, but unfortunately there is simply so much free cash sloshing around seeking "some action" and a lot of speculators are simply unable to resist the urge to try to run commodities prices back up since "it worked before." My view is that there is a fairly good chance that prices of energy commodities will recede in the coming months, but it may be too soon to bet too heavily against the speculators. My finger is on the trigger, but for now I'll retain my belief that the Fed will remain paused for at least another year.

My current feeling is that the 0.7% Q1 GDP number has frightened so many people (and emboldened so many bears and cynics) that the Fed will likely simply wait until the Q2 GDP number "prints" in late July before seriously considering a rate hike in August. Another line of thought suggests that after the apparently weak Q1, the Fed will want to see two full quarters (Q2 and Q3) of reasonably robust economic growth before risking another hike.

I am not suggesting that the Fed will "target" commodities prices such as crude oil and gasoline, but that the Fed will be noticing the degree to which elevated commodities prices are influencing the rest of the economy and pushing up even core prices over time. The price of crude oil remains up at $70.68 (up sharply from $68.00 two weeks ago), which has to concern the Fed. The Fed is usally quite tolerant of short-term energy and food price spikes because they tend to quickly recede, but oil and gasoline and other energy prices have remained persistently high for a prolonged period of time, which results in upwards pressure on core, non-energy prices. Wholesale gasoline remains well above $2, and at $2.2942 last week (up sharply from $2.2601 two weeks ago) indicates an equilibrium retail level of $2.89 to $2.94, which is too far above $2 to give the Fed any comfort that inflationary pressures are "subdued."

My latest thinking is that $60 may be the magic number for crude oil for the Fed in June even though $50 is what they would really like to see. If crude is $60 or higher in July, the Fed will have a higher probability of a hike to 5.50% in August or September. If crude is below $50, the probability of a hike is very low. If crude is at $55, it will be a 50/50 coin flip. At $58, the Fed would seriously consider a hike. At $53, the Fed would likely hike only if there were some other significant factors, such as a strong resurgence in housing demand.

The point here is not $58 crude oil per se, but the fact that $58 crude oil means that either real demand is overly strong, or there is too much monetary liquidity in the financial system that inspires speculators to throw too much money around because it is relatively too cheap and the Fed will feel some pressure to "mop up" such excess liquidity to the extent that it causes higher core inflation in the real economy.

Although the moderation of the housing boom will indeed hold back the economy over the next couple of quarters, the Fed seems to agree with me that this is to be expected and not an indicator of a coming recession. A lot of people have been desperately funneling money into bond funds in response to an expectation of well below-par economic growth, and this has depressed Treasury yields and caused an inverted yield curve, but this is ultimately indicating only below-par growth (e.g., 2.25% to 3.25% rather than 3+%) for the coming six months. Yes, there is a lot of anxiety, but anxiety itself is not a reliable indicator of a particular outcome.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive. All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer. The odds of such a hike causing a recession are negligible.

Note: There were reports this past week that Kansas City Federal Reserve Bank President Thomas Hoenig publicly characterized the federal funds rate at 5.25% as "in my judgment that is modestly restrictive, not severely, but modestly so." To my knowledge, he is the only and first Fed official to chacterize current monetary policy as "restrictive." It is worth noting that he felt the need to insert the caveat "in my judgment", suggesting that he does in fact recognize that it is his opinion and not offical Fed policy. I will keep my ears open for any such statements from other Fed officials. Some media reports quoted Hoenig as saying "moderately restrictive", and since the text of his remarks were not offficially posted or reported in full transcript form, we don't know for sure what he actually said or the actual immediate context. We should not take the public statements of any Fed official lightly, but sometimes individual Fed officials might choose to stray from the official policy, either by their own design or inadvertently. President Hoenig was speaking to a group of local bankers and businessmen in Cody, Wyoming, so he may simply have chosen more casual language that they would be more likely to understand than the more arcane "Fedspeak" that normally requires even motivated Fed followers to be very careful when they dissect it. Unless we hear at least two more Fed officials speak in the same terms of monetary policy as being "restrictive" within the next couple of weeks, it may be safe to write off Hoenig's characterization as being a one-time abberation to normal Fed communication about monetary policy and that Fed monetary policy does in deed remain in a "neutral range" rather than being "restrictive", let alone "moderately restrictive."

According to a report from Bloomberg,  Peter Hooper, chief economist at Deutsche Bank Securities characterized the Fed position by saying that "Their general feeling is at 5 1/4 percent, the fed funds rate is probably slightly restrictive." That is his characterization, his opinion, but that is not a position that has been officially or generally espoused by the Fed. Besides, "slightly restrictive" is clearly not "moderately restrictive."

Update: There has been no further suggestion that Fed policy is "restrictive", so I think it is safe to conclude that the overall view of the Fed is that their intention is that policy is in the "neutral range" and not "restrictive."

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• August 7, 2007: 4% chance of a cut -- slam dunk for no change
• September 18, 2007: 8% chance of a cut
• October 30/31, 2007: 16% chance of a cut
• December 11, 2007: 32% chance of a cut
• January 2008: 42% chance of a cut
• March 2008: 58% chance of a cut -- a bit better than a coin flip chance that a cut is likely
• May 2008: 70% chance of a cut -- a cut is likely
• June 2008: 76% chance of a cut -- a cut is likely

The August FOMC meeting is now within the 45-day window of reliability for fed funds futures to predict Fed action, so it is reasonably certaint that the Fed will not change the fed funds target rate at the August FOMC meeting. It is too soon for fed funds futures to reliably predict rates for the September or October FOMC meetings. A lot can and will transpire during the run-up to the August and September meetings to whipsaw the odds for a rate change at those meetings. My belief is that we will continue to see rising odds for a hike in August or September or the Fall.

I would note that such betting can change on a moment's notice as economic and financial data, not to mention commentary and sentiment, unfolds and evolves. Like it or not, the economy proceeds more through Darwinian evolution than "intelligent design." Emergent phenomena and evolution are the norms for the economy. The Fed (and Wall Street) can influence the evolution, of the economy, but not control it as if it were a clockwork machine. Predicting the precise or even general impact of any Fed action or inaction is quite literally a fool's errand. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet." Finally, studies have shown that Fed funds futures are not a very reliable indicator more than 45 days into the future.

What the Fed funds futures market tells us clearly is that the Fed will most likely leave rates unchanged for the rest of the year. Futures suggest a rate cut in March or April, but that is too far in the future for the market to give a reliable forecast.

My feeling is that since the housing retrenchment and so-called subprime "crisis" didn't cause a Fed cut at the January (or March) FOMC meeting, it is unlikely that housing or the so-called subprime "crisis" will be enough of a problem to cause a Fed cut for the rest of the year either.

As of the June 28, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research dramatically revised its forecast and now calls for a Fed funds rate of 5.00% by the end of 2007 (versus a forecast of 4.50% just two weeks ago) and a total of three quarter-point cuts rather than six. They tell us that "The healthier US economy prompts us to delay the first Fed cut to December from September 2007 and to expect less total easing of 75 basis points instead of 150." They now forecast a Fed funds rate of 4.50% by the end of 2008 compared to their forecast of 3.75% just two weeks ago. They continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective. It sounds to me that their commitment to their "call" is rapidly crumbling and that they themselves are on the verge of admitting that they are clueless.

Why would the UBS outlook be so far off from my own view or even from the pessimistic market view? The wide divergence of these views doesn't make sense, right? Well, that's true if one were considering only economic fundamentals, but we do need to take into account that UBS has a customer base that they want to preserve and that the "research" document I referenced is really marketing literature, most likely designed to make the existing UBS customer base feel that UBS is "in touch" with their customers and their "needs." That is par for the course with the big financial firms. Step 1 is to understand the hopes and fears and anxieties of your customers and step 2 is to directly tap into those hopes and fears and anxieties. Right now, a lot of people hear so many desperate and gloomy stories in the media and internalize that desperation and gloom, and the result is that firms like UBS have no choice but to send out a message of "we understand and share your fears and anxieties." Better to be wrong and keep your customer base than be right and lose your customers. The bottom line is that individual investors cannot look to the research and economic outlooks peddled by Wall Street for a balanced accurate view of how the conomy and businesses will likely unfold in the coming months or year or over any period of time.

The bottom line here is that the Fed won't move over the rest of the year or even the coming twelve months, and any speculation about Fed moves further down the road are simply wild guesses based on contrived stories about a hypothetical future economy that happens to have a mind of its own.

Why are so many smart people so confused about the future? It is simply the fact that the conservative thing for them to do is to assume that economic events such as housing booms always play out in the same pattern every single time. For a bureaucrat, that is always the safe approach. Alas, every economic episode has its own idiosyncratic pattern and the real issue is how to forecast the interactions between the many sectors and regions of the economy, and that is a really hard problem that is absolutely not amenable to the cookie-cutter application of historical patterns.

The current "herd mentality" on Wall Street is basically sending so many speculators and even investors off on a truly wild goose chase, after which Wall Street will quietly acknowledge its error ("the data changed in an unexpected manner") and then chase those same speculators and investors back in the opposite direction, making sure to collect transaction fees and spreads on both legs of the roundtrip "chase." Expect to see a reversal of the trend of the past week within a month.

The Weekly Leading Index of the Economic Cycle Research Institute is telling us, according to Lakshman Achuthan, managing director at ECRI, that "With WLI growth at its highest reading in over three years, U.S. economic growth is bound to pick up in the months ahead."

Maybe I really should go on a hiatus for this Fed post series since the markets and most Wall Street "professionals" have finally actually come around to my position after these many long months. Maybe I'll put this Fed post series into hibernation until I can sense that I have something different to say than what Wall Street and the fed funds futures are now telling us. It would appear that my work here is done. There is still some mopping up to do and plenty of opportunity for backsliding by Wall Street "professionals," so maybe I should say "I'll be back."

Update: The backsliding of the market over the past two weeks to a renewed expectation for a single cut in Q2 of 2008 demanded this update, but my hope is that I won't need to do another update until we see some significant change in the economic picture in July or August.

-- Jack Krupansky

PayPal money market fund yield remains at 5.04% as of 6/30/2007

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet. Note: Since I was out on vacation for a week, most changes are from two weeks ago.]

Here are some recent money market mutual fund yields as of Saturday, June 30, 2007:

• iMoneyNet average taxable money market fund 7-day yield fell from 4.72% to 4.70%
• TIAA-CREF Money Market (TIRXX) 7-day yield fell from 5.18% to 5.13%
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield rose from 5.12% to 5.14%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield rose from 5.08% to 5.09%
• PayPal Money Market Fund 7-day yield remains at 5.04%
• ShareBuilder money market fund (BDMXX) 7-day yield fell from 4.47% to 4.46%
• Fidelity Money Market Fund (SPRXX) 7-day yield rose from 4.99% to 5.02% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield rose from 4.96% to 4.98%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield rose from 4.46% to 4.48%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield rose from 3.28% to 3.37% or tax equivalent yield of 5.18% (up from 5.05%) for the 35% marginal tax bracket and 4.68% (up from 4.56%) for the 28% marginal tax bracket -- this may be the best rate that most of us can get for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield rose from 3.26% to 3.33% or tax equivalent yield of 5.12% (up from 5.02%) for the 35% marginal tax bracket and 4.53% (up from 4.53%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate rose from 4.42% to 4.58%
• 13-week (3-month) T-bill investment rate rose from 4.62% to 4.82%
• 26-week (6-month) T-bill investment rate rose from 4.91% to 5.01%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• Schwab Bank Investor Checking APY remains at 4.25%
• Schwab Value Advantage Money Fund (SWVXX) 7-day yield fell from 4.92% to 4.91%
• Schwab Investor Money Fund (SW2XX) 7-day yield remains at 4.74%
• Charles Schwab 3-month CD APY remains at 5.04%
• Charles Schwab 6-month CD APY fell from 5.21% to 5.16%
• Charles Schwab 1-year CD APY fell from 5.26% to 4.25% (Yes, their web site says 4.25%, not 5.25%, but I suspect a typo!)
• NetBank 6-month CD APY remains at 5.40%
• NetBank 1-year CD APY remains at 5.40%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

PayPal continues to be a fairly interesting place to store cash for both relatively quick access and a well above average yield. There is no minimum for a PayPal account, no fee for a basic account, and it can be linked to your bank checking account or even your brokerage checking account for easy access. Right now I am using PayPal as a savings account, putting a little more money in whenever I get a chance and feel that my budget has some "spare change." The PayPal 7-day yield of 5.04% is equivalent to a bank APY of 5.16%. I plan to put more money into PayPal today.

I wasn't aware of the high-yield TAA-CREF and Vanguard money market mutual funds before and I don't know much about them, but they are the highest yielding money market mutual funds out there for us retail investors, so I'll follow them and look into them a bit more closely. At this stage, it is still unclear if they really are available to all of us individual retail investors or if there are restrictions or fees that might reduce their attractiveness, but they do seem rather attractive, especially as an alternative to CDs.

4-week T-bills continue to not look as attractive a place for cash that you won't need for a month, since the new issue yield remains well below the yield of PayPal and Fidelity Cash Reserves, but this rate fluctuates significantly from week to week. The rate is locked in for four weeks once you buy the T-bill at the weekly auction, but you can't predict what rate you will get at the next auction since it is based on supply and demand. Simply letting the T-bills automatically roll every four weeks will average out a lot of this volatility. Frankly, the extreme volatility with frequent low yields has turned me off to T-bills in favor of PayPal and Fidelity Cash Reserves, but we'll see how yields evolve over the coming months. I believe that the low yield is due to turmoil in the bond market, with people dumping longer-term bonds and shifting money towards the shorter end of the Treasury yield curve. More money flowing in drives up the price, which lowers the yield.

Check Bankrate.com for the availability of high-rate CDs (5.00% APY to 5.46% APY for 6-month). Alas, there are frequently quite a few caveats, strings, restrictions, requirements, minimums, "introductory specials", and other gotchas, so read the fine print carefully. And some of these banks may have been involved in the subprime lending mess, so you might want to avoid them out of principle even if your principal is protected by the FDIC. CDs work great for some people, but horribly for others. I have no CDs since I do not have any free cash that I can afford to lock up with restrictions for even three months. But, that said, I am considering putting at least a little free cash in short-term CDs (three-month, six-month, or maybe even one-year), around the middle of 2007, especially if the Fed raises interest rates by a quarter-point in June or August. My current thinking is that although I can get a moderate increment of yield from a CD (e.g., from NetBank), the additional hassles don't seem worth the effort compared to the simplicity and flexibility I get with PayPal and Fidelity FDRXX. CDs would be worth the effort if I had a lot more cash, but I don't. And if you are up in the 35% tax bracket, a tax-free money market mutual fund (like FTEXX) may be a better deal.

Please note the disclaimer on Fidelity's web site for mutual funds:

Past performance is no guarantee of future results. Yield will vary.

As always, please note that cash placed in money market mutual funds is subject to the disclaimer that:

An investment in the Fund is not insured or guaranteed by the Federal Insurance Deposit Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

In practice, that is not a problem at all, but it does incline me to spread my money around a bit.

T-bills and the cash in your bank checking and savings accounts or bank CDs are of course "protected", either by "the full faith and credit of the U.S. Treasury" or the FDIC. Please realize that you may not get your full principle back if you attempt to cash out early for Treasury securities since you'll get the price on the open market, which is not guaranteed by the U.S. Treasury. You are only assured of getting your full principle if your Treasury security is held until maturity (or Treasury "calls" the security or issues an offer to repurchase.)

I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an "indication" of future returns.

-- Jack Krupansky

ECRI Weekly Leading Index indicator steady and continues to point to a relatively healthy economy in the months ahead

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose very slightly (+0.05% vs. -0.57% last week) while the six-month smoothed growth rate fell modestly (from +6.7% to +6.5%), but remains moderately above the flat line, suggesting that the economy continues to retain much of the steam that it had picked up. The smoothed growth rate has been positive for 34 consecutive weeks. We haven't finished the soft landing yet, but we are in great shape, despite the weakness in the housing sector, the misleadingly low GDP report for Q1, and the feverish hand-wringing of the pundits.

The WLI is now 47 weeks past its low of last summer and the six-month smoothed growth rate is now 44 weeks past its low. Although not signalling an outright boom, this is a fairly dramatic recovery from the somewhat dark times of last summer.

A WLI growth rate of zero (0.0) would indicate an economy that is running at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to be a relatively stable "Goldilocks" economy. We're actually doing somewhat better than that now.

Although the WLI smoothed growth rate remains relatively modest and will likely remain so for the next few months, it isn't showing any signs of the kind of persistent and growing weakness (values more negative than -1.5% over a period of time) that would be seen in an economy that was slowing on its way into recession, but does look a lot like an economy moderating on its way to a relatively stable growth rate.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate. Goldilocks might not be completely happy with the current state of the economy, but she should be. Ditto for NYU Professor Nouriel Roubini. Sorry Nouriel, but Professor Ben Bernanke has it right this time. Anyone expecting a recession or very weak economy (under +1.00% -- average over at last half of the year) this year will be disappointed.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates "clear weather" for the next few months.

-- Jack Krupansky

Gasoline almost back under $3

I was reading an article on Bloomberg by Bob Willis and Shobhana Chandra entitled "U.S. Economy: Core Prices Ease, Letting Fed Hold Rate (Update1)" and I ran across a quote from Stephen Stanley, chief economist at RBS Greenwich Capital, saying that "Consumers are in a sour mood, with gasoline prices above $3 a gallon," then I said to myself, wait a minute, is that still true?

I went and checked the AAA Daily Fuel Gauge Report and it says that as of Saturday, the nationwide average for regular unleaded gasoline was $3.008. Yeah, technically that is "above" $3, but not by enough to hang your hat on. Yes, prices were well above $3 a gallon a month ago, but have trended downwards consistently since they peaked at $3.227 on May 24.

With the wholesale unleaded gasoline price at $2.26 on Friday, the equilibrium retail price is $2.86 to $2.91, so we should see some further declines to get the headline gasoline price below that $3 psychological level, probably by the end of the week.

-- Jack Krupansky

My excellant credit history??

It has been only eighteen months since I went through personal bankruptcy and even now I cringe at the thought of looking at my credit disclosure, but maybe it isn't as bad as I think. After all, I now have three new unsecured credit cards, one just over a year old, and all of my credit needs are currently met.

One of my preferred credit cards offers airline miles for spending, but the credit limit was somewhat short of being able to cover all of my typical monthly spending plus the accumulated spending during the 20-day grace period. I had cringed at the thought of even asking for an increase in my credit limit, but I was starting to think about it. Then, just yesterday, I get a form letter from the bank that handles the airline credit card telling me that they have automatically doubled my credit limit, which is exactly what I needed.

But what really caught my eye was this statement in the form letter:

And your excellant credit history makes it easy for us to offer you the best product on the market.

My "excellant credit history"? Huh? What about my personal bankruptcy? Well, my credit record since bankruptcy has in fact been spotless and I have been responsibly using these three credit cards for over a year now, so maybe my credit history really is "excellant", by at least some standards.

Still, the memory of all those lean years and financial difficulties are still too fresh in my mind to accept the concept of "your excellant credit history."

Maybe all the talk about bankruptcy being on your credit record for so many years really is just a scare tactic and not an accurate reflection of how lenders actually view credit risk.

-- Jack Krupansky

Cost of living increases and inflation are not really the same

The headline of the article by Jeremy Peters in The New York Times says "Cost of Gas and Food Rose Sharply Last Month" although the article does admit that "an important gauge of inflation drifted lower." Why the conflicting messages? The answer, as you might suspect, is that "it all depends." Literally, it depends on exactly what you want to measure and over what timeframe.

At a human emotional level, people respond very negatively to short-term price spikes, such as we saw with energy prices in May, but less emotionally to gradual rises over time and even pleasant price declines that may be as large as a previous price spike.

Another issue is that there is a huge difference between "cost of living increase" and "inflation." The former is a phenomenon of micro-economics, whereas the latter is a phenomenon of macro-economics. The former relates to how much money people have in their pockets and paychecks in the here and now, whereas the latter is of concern to economists over relatively long periods of time (but measured at annualized rates) and independent of short-term fluctuations.

One bizarre consequence of the difference between these micro-economic and macro-economic concerns is that in fact inflation might be relatively low over a period of time while consumers could be experiencing significant anguish over accumulated price increases that are causing them far more pain than any current inflation. In other words, consumers feel far more pain from past price increases than any satisfaction they might get that prices have actually improved in the past few weeks.

Macro-economists are not really concerned about price spikes in general since they frequently dissipate and even reverse over the medium term. These economists are concerned much more with the average over an extended period of time (quarters and years) than short-term effects (month to month.)

This is why macro-economists look at "core" inflation, since they do not care about transient price changes that don't feed back into core prices within the medium time scale.

Yes, consumers do "have to eat and buy gas", but macro-economics is about the big picture over an extended time scale, and they assume that food and energy prices will in fact moderate over time. The obvious paradox is that macro-economists are only looking at annual rates without looking at accumulated price increases over a number of years. 2% a year over ten years seems benign at a one-year interval but amounts to over 20% over a ten-year period. Or even a 1.5% annual rise which would be considered almost "ideal" by many economists still amounts to 15% over ten years or 30% over twenty years. It is ironic that macro-economists are trying to look at those one-year rates to get closer to the impacts on consumer spending patterns, when it is that accumulated impact on spending power that is causing the real pressure on consumers, over time.

The open question right now is the extent to which elevated energy prices of the past two years will increasingly feed back into core prices since firms which had "absorbed" such price increases in the hope that they would quickly reverse but haven't, so they will be increasingly under pressure to raise prices of everyday goods and services that are included in the core price index.

-- Jack Krupansky

Euro continues to drift sideways with some weakness

The euro continues to drift sideways in the $1.33 to $1.38 trading range. It did in fact break below the narrower  $1.34 to $1.37 range, but not dramatically enough and long enough to constitute a true breakdown. For now, the overall trend is neither up nor down, but "sideways." Euro futures closed on Friday at $1.3419, 0.53 cents above the $1.3366 level of a week ago. I strongly suspect that the recent "retreat" was more of a short-term trading phenomenon and not indicative of a longer-term trend per se. I would give the euro bulls and dollar bears a few more shots at $1.37 and $1.38 over the next month before concluding that the euro is likely to weaken for the rest of the year.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, a decent Q2 GDP report in July, and a strong hint of a rate hike in August or the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.37 range as long as there is any superficially bad news to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."]

-- Jack Krupansky

Fed remains likely to stay on course at 5.25% for all of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet. I will be unlikely to do this post on June 23 since I will be on vacation in New York City.]

Fed funds futures are now suggesting that most people are now betting that the Fed will be "on hold", for at least the entire next year, out through at least June 2008. The odds of a Fed rate cut during the coming year have completely evaporated and even turned into very modest odds of a rate hike.

For now, my overall assessment of Fed monetary policy remains:

My view is that the Fed will keep the Fed funds target rate paused at 5.25% for all of 2007, and probably well into 2008.

There will not be a recession this year, nor even enough of a growth slump to trigger a Fed rate cut.

The Fed will not cut rates in response to the concern about subprime mortgages.

The Fed will not worry about the health of the economy since it is MUCH healthier than the 0.6% Q1 "real" GDP growth rate "estimate" suggests.

I would suggest that there is a 1 in 3 chance that the Fed will hike rates by a quarter-point at either the August or the September FOMC meeting.

I tentatively say "for now" because I remain half-convinced that the Fed may in fact feel the need to make another hike in August or September to 5.50%. To my way of thinking, it all depends on what happens with energy commodities. Prices of oil and gasoline futures are still quite elevated, albeit off their Summer peaks, and this constitutes an ongoing source of inflationary pressure that continues to propagate throughout the economy. If prices of energy commodities resume their decline, the Fed will be able to remain paused for all of 2007. But if energy commodities prices do not continue to fall, the Fed may have little choice but to hike to 5.50% in August or September. If we don't see crude oil consistently below $50 and retail unleaded gasoline consistently under $2.00 by July, expect a Fed hike to 5.50% at the August or September FOMC meeting. Based on economic fundamentals, we should see the prices of energy commodities come back down to Earth, but unfortunately there is simply so much free cash sloshing around seeking "some action" and a lot of speculators are simply unable to resist the urge to try to run commodities prices back up since "it worked before." My view is that there is a fairly good chance that prices of energy commodities will recede in the coming months, but it may be too soon to bet too heavily against the speculators. My finger is on the trigger, but for now I'll retain my belief that the Fed will remain paused for at least another year.

My current feeling is that the 0.6% Q1 GDP number has frightened so many people (and emboldened so many bears and cynics) that the Fed will likely simply wait until the Q2 GDP number "prints" in late July before seriously considering a rate hike in August.

I am not suggesting that the Fed will "target" commodities prices such as crude oil and gasoline, but that the Fed will be noticing the degree to which elevated commodities prices are influencing the rest of the economy and pushing up even core prices over time. The price of crude oil remains up at $68.00 (up sharply from $64.76 a week ago), which has to concern the Fed. The Fed is usally quite tolerant of short-term energy and food price spikes because they tend to quickly recede, but oil and gasoline and other energy prices have remained persistently high for a prolonged period of time, which results in upwards pressure on core, non-energy prices. Wholesale gasoline remains well above $2, and at $2.2601 last week (up very sharply from $2.1271 a week ago) indicates an equilibrium retail level of $2.86 to $2.91, which is too far above $2 to give the Fed any comfort that inflationary pressures are "subdued."

My latest thinking is that $60 may be the magic number for crude oil for the Fed in June even though $50 is what they would really like to see. If crude is $60 or higher in July, the Fed will have a higher probability of a hike to 5.50% in August or September. If crude is below $50, the probability of a hike is very low. If crude is at $55, it will be a 50/50 coin flip. At $58, the Fed would seriously consider a hike. At $53, the Fed would likely hike only if there were some other significant factors, such as a strong resurgence in housing demand.

The point here is not $58 crude oil per se, but the fact that $58 crude oil means that either real demand is overly strong, or there is too much monetary liquidity in the financial system that inspires speculators to throw too much money around because it is relatively too cheap and the Fed will feel some pressure to "mop up" such excess liquidity to the extent that it causes higher core inflation in the real economy.

Although the moderation of the housing boom will indeed hold back the economy over the next couple of quarters, the Fed seems to agree with me that this is to be expected and not an indicator of a coming recession. A lot of people have been desperately funneling money into bond funds in response to an expectation of well below-par economic growth, and this has depressed Treasury yields and caused an inverted yield curve, but this is ultimately indicating only below-par growth (e.g., 2.25% to 3.25% rather than 3+%) for the coming six months. Yes, there is a lot of anxiety, but anxiety itself is not a reliable indicator of a particular outcome.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive. All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer. The odds of such a hike causing a recession are negligible.

Note: There were reports this past week that Kansas City Federal Reserve Bank President Thomas Hoenig publicly characterized the federal funds rate at 5.25% as "in my judgment that is modestly restrictive, not severely, but modestly so." To my knowledge, he is the only and first Fed official to chacterize current monetary policy as "restrictive." It is worth noting that he felt the need to insert the caveat "in my judgment", suggesting that he does in fact recognize that it is his opinion and not offical Fed policy. I will keep my ears open for any such statements from other Fed officials. Some media reports quoted Hoenig as saying "moderately restrictive", and since the text of his remarks were not offficially posted or reported in full transcript form, we don't know for sure what he actually said or the actual immediate context. We should not take the public statements of any Fed official lightly, but sometimes individual Fed officials might choose to stray from the official policy, either by their own design or inadvertently. President Hoenig was speaking to a group of local bankers and businessmen in Cody, Wyoming, so he may simply have chosen more casual language that they would be more likely to understand than the more arcane "Fedspeak" that normally requires even motivated Fed followers to be very careful when they dissect it. Unless we hear at least two more Fed officials speak in the same terms of monetary policy as being "restrictive" within the next couple of weeks, it may be safe to write off Hoenig's characterization as being a one-time abberation to normal Fed communication about monetary policy and that Fed monetary policy does in deed remain in a "neutral range" rather than being "restrictive", let alone "moderately restrictive."

According to a report from Bloomberg,  Peter Hooper, chief economist at Deutsche Bank Securities characterized the Fed position by saying that "Their general feeling is at 5 1/4 percent, the fed funds rate is probably slightly restrictive." That is his characterization, his opinion, but that is not a position that has been officially or generally espoused by the Fed. Besides, "slightly restrictive" is clearly not "moderately restrictive."

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• June 27/28, 2007: 0% chance of a cut -- slam dunk for no change
• August 7, 2007: 2% chance of a hike
• September 18, 2007: 0% chance of a cut
• October 30/31, 2007: 0% chance of a cut
• December 11, 2007: 4% chance of a hike
• January 2008: 4% chance of a hike
• March 2008: 0% chance of a cut
• May 2008: 0% chance of a cut

The June FOMC meeting is well within the 45-day window of reliability for fed funds futures to predict Fed action, so it is a virtual certainty that the Fed will not change the fed funds target rate at the June FOMC meeting. It is too soon for fed funds futures to reliably predict rates for the August or September FOMC meetings. A lot can and will transpire during the run-up to the June and August meetings to whipsaw the odds for a rate change at those meetings. My belief is that we will continue to see rising odds for a hike in August or September or the Fall.

I would note that such betting can change on a moment's notice as economic and financial data, not to mention commentary and sentiment, unfolds and evolves. Like it or not, the economy proceeds more through Darwinian evolution than "intelligent design." Emergent phenomena and evolution are the norms for the economy. The Fed (and Wall Street) can influence the evolution, of the economy, but not control it as if it were a clockwork machine. Predicting the precise or even general impact of any Fed action or inaction is quite literally a fool's errand. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet." Finally, studies have shown that Fed funds futures are not a very reliable indicator more than 45 days into the future.

What the Fed funds futures market tells us clearly is that the Fed will most likely leave rates unchanged for the next 12 months. The market is not predicting any cuts out as far as Fed futures trade (that I can see), but that is too far in the future for the market to give a reliable forecast.

My feeling is that since the housing retrenchment and so-called subprime "crisis" didn't cause a Fed cut at the January (or March) FOMC meeting, it is unlikely that housing or the so-called subprime "crisis" will be enough of a problem to cause a Fed cut for the rest of the year either.

As of the June 15, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research continues to forecast a Fed funds rate of 4.50% by the end of 2007, but they do admit that "We acknowledge that our Fed call is too aggressive, both in timing and magnitude, which are under review", but then they stumble back into their rathole by telling us that "Nevertheless, we continue to think that the next move by the Fed will be a rate cut..." They continue to forecast a Fed funds rate of 3.75% by the end of 2008. They continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective. It sounds to me that their commitment to their "call" is rapidly crumbling and that they themselves are on the verge of admitting that they are clueless.

Why would the UBS outlook be so far off from my own view or even from the pessimistic market view? The wide divergence of these views doesn't make sense, right? Well, that's true if one were considering only economic fundamentals, but we do need to take into account that UBS has a customer base that they want to preserve and that the "research" document I referenced is really marketing literature, most likely designed to make the existing UBS customer base feel that UBS is "in touch" with their customers and their "needs." That is par for the course with the big financial firms. Step 1 is to understand the hopes and fears and anxieties of your customers and step 2 is to directly tap into those hopes and fears and anxieties. Right now, a lot of people hear so many desperate and gloomy stories in the media and internalize that desperation and gloom, and the result is that firms like UBS have no choice but to send out a message of "we understand and share your fears and anxieties." Better to be wrong and keep your customer base than be right and lose your customers. The bottom line is that individual investors cannot look to the research and economic outlooks peddled by Wall Street for a balanced accurate view of how the conomy and businesses will likely unfold in the coming months or year or over any period of time.

The bottom line here is that the Fed won't move over the rest of the year or even the coming twelve months, and any speculation about Fed moves further down the road are simply wild guesses based on contrived stories about a hypothetical future economy that happens to have a mind of its own.

Why are so many smart people so confused about the future? It is simply the fact that the conservative thing for them to do is to assume that economic events such as housing booms always play out in the same pattern every single time. For a bureaucrat, that is always the safe approach. Alas, every economic episode has its own idiosyncratic pattern and the real issue is how to forecast the interactions between the many sectors and regions of the economy, and that is a really hard problem that is absolutely not amenable to the cookie-cutter application of historical patterns.

The current "herd mentality" on Wall Street is basically sending so many speculators and even investors off on a truly wild goose chase, after which Wall Street will quietly acknowledge its error ("the data changed in an unexpected manner") and then chase those same speculators and investors back in the opposite direction, making sure to collect transaction fees and spreads on both legs of the roundtrip "chase." Expect to see a reversal of the trend of the past week within a month.

The Weekly Leading Index of the Economic Cycle Research Institute is telling us, according to Lakshman Achuthan, managing director at ECRI, that "With WLI growth at its highest reading in over three years, U.S. economic growth is bound to pick up in the months ahead."

Maybe I really should go on a hiatus for this Fed post series since the markets and most Wall Street "professionals" have finally actually come around to my position after these many long months. Maybe I'll put this Fed post series into hibernation until I can sense that I have something different to say than what Wall Street and the fed funds futures are now telling us. It would appear that my work here is done. There is still some mopping up to do and plenty of opportunity for backsliding by Wall Street "professionals," so maybe I should say "I'll be back."

-- Jack Krupansky

PayPal money market fund yield remains at 5.04% as of 6/16/2007

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet. It is unlikely that I will be posting on June 23 since I'll be on vacation in New York City.]

Here are some recent money market mutual fund yields as of Saturday, June 16, 2007:

• iMoneyNet average taxable money market fund 7-day yield remains at 4.72%
• TIAA-CREF Money Market (TIRXX) 7-day yield fell from 5.22% to 5.18%
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield rose from 5.11% to 5.12%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield rose from 5.07% to 5.08%
• PayPal Money Market Fund 7-day yield remains at 5.04%
• ShareBuilder money market fund (BDMXX) 7-day yield rose from 4.46% to 4.47%
• Fidelity Money Market Fund (SPRXX) 7-day yield rose from 4.98% to 4.99% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield remains at 4.96%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield rose from 4.44% to 4.46%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield fell from 3.35% to 3.28% or tax equivalent yield of 5.05% (down from 5.15%) for the 35% marginal tax bracket and 4.56% (down from 4.65%) for the 28% marginal tax bracket -- this may be the best rate that most of us can get for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield fell from 3.33% to 3.26% or tax equivalent yield of 5.02% (down from 5.12%) for the 35% marginal tax bracket and 4.53% (down from 4.62%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate fell from 4.75% to 4.64%
• 13-week (3-month) T-bill investment rate fell from 4.85% to 4.77%
• 26-week (6-month) T-bill investment rate fell from 4.99% to 4.96%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• Schwab Bank Investor Checking APY remains at 4.25%
• Schwab Value Advantage Money Fund (SWVXX) 7-day yield rose from 4.91% to 4.92%
• Schwab Investor Money Fund (SW2XX) 7-day yield remains at 4.74%
• Charles Schwab 3-month CD APY fell from 5.10% to 5.04%
• Charles Schwab 6-month CD APY rose from 5.16% to 5.21%
• Charles Schwab 1-year CD APY rose from 5.20% to 5.26%
• NetBank 6-month CD APY rose from 5.35% to 5.40%
• NetBank 1-year CD APY remains at 5.40%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

PayPal continues to be a fairly interesting place to store cash for both relatively quick access and a well above average yield. There is no minimum for a PayPal account, no fee for a basic account, and it can be linked to your bank checking account or even your brokerage checking account for easy access. Right now I am using PayPal as a savings account, putting a little more money in whenever I get a chance and feel that my budget has some "spare change." The PayPal 7-day yield of 5.04% is equivalent to a bank APY of 5.16%.

I wasn't aware of the high-yield TAA-CREF and Vanguard money market mutual funds before and I don't know much about them, but they are the highest yielding money market mutual funds out there for us retail investors, so I'll follow them and look into them a bit more closely. At this stage, it is still unclear if they really are available to all of us individual retail investors or if there are restrictions or fees that might reduce their attractiveness, but they do seem rather attractive, especially as an alternative to CDs.

4-week T-bills once again do not look as attractive a place for cash that you won't need for a month, since the new issue yield is now well below the yield of PayPal and Fidelity Cash Reserves, but this rate fluctuates significantly from week to week. The rate is locked in for four weeks once you buy the T-bill at the weekly auction, but you can't predict what rate you will get at the next auction since it is based on supply and demand. Simply letting the T-bills automatically roll every four weeks will average out a lot of this volatility. Frankly, the extreme volatility with frequent low yields has turned me off to T-bills in favor of PayPal and Fidelity Cash Reserves, but we'll see how yields evolve over the coming months. I believe that the low yield is due to turmoil in the bond market, with people dumping longer-term bonds and shifting money towards the shorter end of the Treasury yield curve. More money flowing in drives up the price, which lowers the yield.

Check Bankrate.com for the availability of high-rate CDs (5.00% APY to 5.46% APY for 6-month). Alas, there are frequently quite a few caveats, strings, restrictions, requirements, minimums, "introductory specials", and other gotchas, so read the fine print carefully. And some of these banks may have been involved in the subprime lending mess, so you might want to avoid them out of principle even if your principal is protected by the FDIC. CDs work great for some people, but horribly for others. I have no CDs since I do not have any free cash that I can afford to lock up with restrictions for even three months. But, that said, I am considering putting at least a little free cash in short-term CDs (three-month, six-month, or maybe even one-year), around the middle of 2007, especially if the Fed raises interest rates by a quarter-point in June or August. My current thinking is that although I can get a moderate increment of yield from a CD (e.g., from NetBank), the additional hassles don't seem worth the effort compared to the simplicity and flexibility I get with PayPal and Fidelity FDRXX. CDs would be worth the effort if I had a lot more cash, but I don't. And if you are up in the 35% tax bracket, a tax-free money market mutual fund (like FTEXX) may be a better deal.

Please note the disclaimer on Fidelity's web site for mutual funds:

Past performance is no guarantee of future results. Yield will vary.

As always, please note that cash placed in money market mutual funds is subject to the disclaimer that:

An investment in the Fund is not insured or guaranteed by the Federal Insurance Deposit Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

In practice, that is not a problem at all, but it does incline me to spread my money around a bit.

T-bills and the cash in your bank checking and savings accounts or bank CDs are of course "protected", either by "the full faith and credit of the U.S. Treasury" or the FDIC. Please realize that you may not get your full principle back if you attempt to cash out early for Treasury securities since you'll get the price on the open market, which is not guaranteed by the U.S. Treasury. You are only assured of getting your full principle if your Treasury security is held until maturity (or Treasury "calls" the security or issues an offer to repurchase.)

I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an "indication" of future returns.

-- Jack Krupansky

Searching for finance, banking, economic, and stock and bond market terms

If you want to look up the meaning of a term related to finance, banking, economics, or the stock and bond market, try the Babylon.com Search for Banking Terms:

Glossaries of economy and finances with detailed explanations of words, acronyms and definitions belonging to the finance and banking terminology. One search box permits you to search multiple online dictionaries, including:

• Campbell R. Harvey's Hypertextual Finance Glossary
• UNODC Money-Laundering Terms
• European Central Bank Glossary

-- Jack Krupansky

Budgeting for a new PC

Oops, one of the items I didn't even consider for my budget for the coming year was a new notebook computer. My current computer, a two-year old Toshiba Satellite, is working fine and could serve me well for another whole year or even two, but you never know.

My "standard" budget for a notebook computer is $1,500 every two years, with the hope that I can get three or even four years out of it. Based on technology advances and the fact that I no longer need to do any serious software development work on my home computer, I'm expecting to downsize that budget to at least $1,250, if not down below $1,000.

I feel fairly confident that I can go another eigthteen months with my current machine, but I should have factored replacement into my budget anyway.

I should also budget software upgrades (Office, FrontPage.)

Opps #2, I forgot to include the annual subscription renewal for anti-virus software.

I haven't done budget plans out into 2009 yet, but I would put $1,250 for a new computer out in June 2009.

-- Jack Krupansky

Beginning second year of my ShareBuilder monthly investment plan

I had been agonizing over whether to continue my year-old ShareBuilder automatic dollar-cost averaging investment plan, but I have finally decided to go ahead with it. That was always going to be my default action, but I do have to admit that the market "swoon" this past week enticed me to continue the plan since the next automatic purchase (on Tuesday) will be a "dip" purchase below the price of some of the purchases in recent months. Of course, that presumes that the market doesn't rally strongly before my purchase gets made on Tuesday. Regardless of whichever scenario plays out in the short term, I feel comforable about the overall U.S. economy and my investment in particular to push on in any case.

There are still other changes I continue to contemplate (like switching to a Roth IRA), but since it is such a modest and sensible plan, continuing it without change for another year seems to be the sensible approach to take at this stage.

-- Jack Krupansky

Expanding my budget horizon

Since I have been having ongoing budget difficulties due to unbudgeted items, and part of that was due to only looking at the next couple of months at any point in time, I've gone ahead and expanded my budgeting horizon all the way out to October 2008 and included all of the non-monthly expenses that had given me problems over the past year. I even budgeted another trip to New York City at the end of the year, a trip to Colorado next March, trips to DC in October and April/May and even October 2008, web hosting expenses, and my accountant tax prep. This gives me full visibility for a full year, and then some. The result is rather ugly with lots of monthly budget holes, but at least I have it all laid out. And, I know that I can fix all of the holes either with built-in budget slack or other "tricks" (like reducing my over-payments on my installment plan for my back taxes) or simply cutting back on one or more trips. I could have done this budget iteration with fewer trips and "made it work", but I'm struggling to be both realistic and conservative, but not overly-restrictive, and to keep as much slack and contingency nets in place as possible.

So, the bad news is that I have a problem. The good news is that I have a clear description of the problem and have tools to tackle it.

Just to note, my retirement plan contributions and participation in the company employee stock purchase plan are all outside of this budget and I treat them the same as taxes since they are payroll deductions that I never see in the payroll deposit into my checking account, so they are in no way at risk regardless what difficulties I have with my monthly "budget" expenses.

-- Jack Krupansky

Gradually getting my budget back on track

My monthly budget had gotten a little off track because I had a few unbudgeted expenses (I spent more on my trip to New York City back in December and put the balance on a 0% credit card, I had a trip to Colorado in March, and I forgot to budget my accountant for tax prep and some web hosting). And then on top of that I decided to take a trip to New York City this month. All of that led to a non-trivial hole in my budget for June. But, I scrimped and saved enough during the past two months to recover most of the shortfall. My current budget for June now actually shows a modest surplus, but unfortunately not enough of a surplus to prevent another modest budget hole in both July and August, although I have a surplus again in September. I actually need a larger surplus each month to cover expenses early in the next month.

I believe that I can completely recover the July and August deficits simply from the fact that my budget always includes a little extra slack so that the budget is greater than my actual expenses. This isn't the situation that I want to be in, but at least I had set up my budget with enough contingency nets so that I'm not in bad shape. My real goal is to have no budget holes and to shovel the surplus into savings.

Another change that I have made is that I am now trying to budget in advance for trips. I expect to go to Washington, D.C. in October, so I have plopped an estimated travel budget in my October budget. That actually leads to a new budget hole in October, but still modest enough that I can probably recover all of it through my normal budget slack without trying the scrimp on actual expenses (which I'll try to do anyway.)

I don't yet have budget spreadsheets beyond October, so I don't have a handle on travel expenses for the end of the year. I really don't have a clear idea what I'll be doing at the end of this year, but I do know that I won't be spending even half of what I spent last year. I may want to try to squeeze in a short trip to San Francisco sometime in the Fall. In any case, this time I'll endeavor to have budget spreadsheets in place well in advance of any travel so that I can come up with solid, rational plans for eliminating budget holes that pop up.

The good news is that I've successfully refrained from dipping into savings or carrying a credit card balance to cover budget holes. All too often, savings can unfortunately be the grease that eases our way down slippery slopes.

Actually, I did carry a credit card balance for my last trip to New York City, but mostly because I had a new credit card that offered 0% finance charge for the first six months. That let me use budget slack to pay off much of the balance and I just made the final payment last week. I'm now looking forward to using that card on a regular basis (and paying off the statement balance every month) since it offers 2% cash back (up to $400 per year in $25 increments.) The 0% finance charge thing did work out fine, but it did require that I exert extra effort and diligence, so I did find it to be a bit of a hassle. I'll try not to do that again unless I really was expecting to pay the balance on the next monthly statement.

In short, I'm still not out of the woods, but I'm making significant progress. I also have a bridge that I can sell you... well, actually I don't -- I'm too honest for that kind of thing.

-- Jack Krupansky

The Treasury yield curve is normal again (not inverted)

Finally, as if by magic, the Treasury yield curve reverted to "normal" this past week rather than being inverted as it has been for many months. The open question is what the significance of the change really means, other than the obvious superficial definition. Some people had insisted that an inverted yield curve absolutely meant that the economy was headed for a recession. For them, I guess they would now have to believe that the U.S. economy is not headed for a recession. For others, the inversion had no indicative meaning but simply meant that demand was high for longer-term Treasuries, possibly due to demand from China or wherever. So, maybe the outsize demand has simply at least partially evaporated. The real bottom line is that the shape of the Treasury yield curve is in a state of flux and that we should wait a few weeks or a month or two before trying to definitively characterize the state of the curve. At a minimum give the Treasury market at least a week for the dust to settle before even starting to think about what all this means.

There was also chatter related to some comments by "Bond King" Bill Gross of PIMCO, suggesting that he was now bearish on longer-term bonds.

As of Friday, the yields for the variaous point on the Treasury yield curve were (according to Bloomberg.com):

• 3-month: 4.76%
• 6-month: 4.92%
• 2-year: 4.99%
• 3-year: 5.02%
• 5-year: 5.04%
• 10-year: 5.11%
• 30-year: 5.21%

What I find interesting is that all of these rates are below the Fed's federal funds rate target of 5.25%, which means that the U.S. government is still funding the federal deficit at rather cheap rates.

-- Jack Krupansky

When to get my free annual credit report

I had been delaying getting my free annual credit report for a number of reasons, but most of those reasons are no longer relevant, so it may be getting close to time for me to request the free annual credit disclosures that every one of us is entitled to through the efforts of the FTC. See AnnualCreditReport.com.

I had been busy and waiting to get my taxes taken care of, but now I am starting to have a little spare time. I did in fact visit the web site and almost requested the free reports, but I decided to wait until the Fall. I want to be a little further away from my bankruptcy back in late 2005, and to have a few more months history on my new credit cards (including a full year on one of them.) I'm not anticipating any activities over the coming six months that might depend on my credit record (such as buying a house), and my record is clearly good enough that it didn't prevent me from getting three normal credit cards without having to pay any special fees or accept onerous terms.

My intention at this point in time is to wait until October and then request my free annual credit file disclosures (for TransUnion, Experian, and Equifax) through the FTC-sponsored web site.

I do have to admit that I cringe at the mere thought of how much credit "debris" I may have on my record due to my bankruptcy, not just the discharged debts, but items that should have been discharged and may still not be annotated correctly.

-- Jack Krupansky

Euro drifting sideways but showing some weakness

The euro continues to drift sideways in the $1.33 to $1.38 trading range. It did in fact break below the narrower  $1.34 to $1.37 range, but not dramatically enough and long enough to constitute a true breakdown. For now, the overall trend is neither up nor down, but "sideways." Euro futures closed on Friday at $1.3366, 0.86 cents below the $1.3452 level of a week ago. I strongly suspect that the recent "retreat" continues to be more of a short-term trading phenomenon and not indicative of a longer-term trend per se. I would give the euro bulls and dollar bears a few more shots at $1.37 and $1.38 over the next couple of weeks before concluding that the euro is likely to weaken for the rest of the year.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, a decent Q2 GDP report in July, and a strong hint of a rate hike in August or the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.37 range for the next few weeks whenever there is any superficially bad news to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as people deeply grasp the truth that the Fed is very unlikely to cut rates over the next six months.

In short, the dollar is not "plunging."

-- Jack Krupansky

Fed remains likely to stay on course at 5.25% for all of 2007 and probably into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

It was truly breathtaking to see some of the big Wall Street heavyweights capitulate and "throw in the towel" on the prospects for Fed rate cuts later this year. Fed funds futures had already shown a dramatic reining in of bearish sentiment a week ago, but this past week gave us public statements from several big players to match the electronic numbers.

For now, my overall assessment of Fed monetary policy remains:

My view is that the Fed will keep the Fed funds target rate paused at 5.25% for all of 2007, and probably into 2008.

There will not be a recession this year, nor even enough of a growth slump to trigger a Fed rate cut.

The Fed will not cut rates in response to the concern about subprime mortgages.

The Fed will not worry about the health of the economy since it is MUCH healthier than the 0.6% Q1 "real" GDP growth rate "estimate" suggests.

I tentatively say "for now" because I remain half-convinced that the Fed may in fact feel the need to make another hike in August or September to 5.50%. To my way of thinking, it all depends on what happens with energy commodities. Prices of oil and gasoline futures are still quite elevated, albeit off their Summer peaks, and this constitutes an ongoing source of inflationary pressure that continues to propagate throughout the economy. If prices of energy commodities resume their decline, the Fed will be able to remain paused for all of 2007. But if energy commodities prices do not continue to fall, the Fed may have little choice but to hike to 5.50% in August or September. If we don't see crude oil consistently below $50 and retail unleaded gasoline consistently under $2.00 by July, expect a Fed hike to 5.50% at the August or September FOMC meeting. Based on economic fundamentals, we should see the prices of energy commodities come back down to Earth, but unfortunately there is simply so much free cash sloshing around seeking "some action" and a lot of speculators are simply unable to resist the urge to try to run commodities prices back up since "it worked before." My view is that there is a fairly good chance that prices of energy commodities will recede in the coming months, but it may be too soon to bet too heavily against the speculators. My finger is on the trigger, but for now I'll retain my belief that the Fed will remain paused for at least another year.

My current feeling is that the 0.6% Q1 GDP number has frightened so many people (and emboldened so many bears and cynics) that the Fed will likely simply wait until the Q2 GDP number "prints" in late July before seriously considering a rate hike in August.

I am not suggesting that the Fed will "target" commodities prices such as crude oil and gasoline, but that the Fed will be noticing the degree to which elevated commodities prices are influencing the rest of the economy and pushing up even core prices over time. The price of crude oil remains up at $64.76 (down modestly from $65.08 a week ago), which has to concern the Fed. The Fed is usally quite tolerant of short-term energy and food price spikes because they tend to quickly recede, but oil and gasoline and other energy prices have remained persistently high for a prolonged period of time, which results in upwards pressure on core, non-energy prices. Wholesale gasoline remains well above $2, and at $2.1271 last week (down very sharply from $2.2512 a week ago) indicates an equilibrium retail level of $2.72 to $2.77, which is too far above $2 to give the Fed any comfort that inflationary pressures are "subdued." There has been some weakness in commodities lately, but it is too soon to suggest a trend reversal to the downside.

My latest thinking is that $60 may be the magic number for crude oil for the Fed in June even though $50 is what they would really like to see. If crude is $60 or higher in July, the Fed will have a higher probability of a hike to 5.50% in August or September. If crude is below $50, the probability of a hike is very low. If crude is at $55, it will be a 50/50 coin flip. At $58, the Fed would seriously consider a hike. At $53, the Fed would likely hike only if there were some other significant factors, such as a strong resurgence in housing demand.

The point here is not $58 crude oil per se, but the fact that $58 crude oil means that either real demand is overly strong, or there is too much monetary liquidity in the financial system that inspires speculators to throw too much money around because it is relatively too cheap and the Fed will feel some pressure to "mop up" such excess liquidity to the extent that it causes higher core inflation in the real economy.

Although the moderation of the housing boom will indeed hold back the economy over the next couple of quarters, the Fed seems to agree with me that this is to be expected and not an indicator of a coming recession. A lot of people have been desperately funneling money into bond funds in response to an expectation of well below-par economic growth, and this has depressed Treasury yields and caused an inverted yield curve, but this is ultimately indicating only below-par growth (e.g., 2% to 2.75% rather than 3+%) for the coming six months. Yes, there is a lot of anxiety, but anxiety itself is not a reliable indicator of a particular outcome.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive. All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer. The odds of such a hike causing a recession are negligible.

Note: There were reports this past week that Kansas City Federal Reserve Bank President Thomas Hoenig publicly characterized the federal funds rate at 5.25% as "in my judgment that is modestly restrictive, not severely, but modestly so." To my knowledge, he is the only and first Fed official to chacterize current monetary policy as "restrictive." It is worth noting that he felt the need to insert the caveat "in my judgment", suggesting that he does in fact recognize that it is his opinion and not offical Fed policy. I will keep my ears open for any such statements from other Fed officials. Some media reports quoted Hoenig as saying "moderately restrictive", and since the text of his remarks were not offficially posted or reported in full transcript form, we don't know for sure what he actually said or the actual immediate context. We should not take the public statements of any Fed official lightly, but sometimes individual Fed officials might choose to stray from the official policy, either by their own design or inadvertently. President Hoenig was speaking to a group of local bankers and businessmen in Cody, Wyoming, so he may simply have chosen more casual language that they would be more likely to understand than the more arcane "Fedspeak" that normally requires even motivated Fed followers to be very careful when they dissect it. Unless we hear at least two more Fed officials speak in the same terms of monetary policy as being "restrictive" within the next couple of weeks, it may be safe to write off Hoenig's characterization as being a one-time abberation to normal Fed communication about monetary policy and that Fed monetary policy does in deed remain in a "neutral range" rather than being "restrictive."

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• June 27/28, 2007: 0% chance of a cut -- slam dunk for no change
• August 7, 2007: 0% chance of a cut
• September 18, 2007: 6% chance of a cut -- effectively zero chance
• October 30/31, 2007: 6% chance of a cut -- effectively zero chance
• December 11, 2007: 8% chance of a cut -- effectively zero chance
• January 2008: 12% chance of a cut -- effectively zero chance
• March 2008: 20% chance of a cut -- people are confused and uncertain, but a cut is still unlikely
• May 2008: 32% chance of a cut -- people are confused and uncertain, but a cut is still unlikely

The June FOMC meeting is well within the 45-day window of reliability for fed funds futures to predict Fed action, so it is a virtual certainty that the Fed will not change the fed funds target rate at the June FOMC meeting. It is too soon for fed funds futures to reliably predict rates for the August or September FOMC meetings. A lot can and will transpire during the run-up to the June and August meetings to whipsaw the odds for a rate change at those meetings. My belief is that the odds of a cut in the coming months and over the coming year will completely evaporate and in fact turn into odds for a hike in August or September or the Fall.

I personally don't concur with these odds after January, but that is how a lot of people are actually "betting." I would simply note that such betting can change on a moment's notice as economic and financial data, not to mention commentary and sentiment, unfolds and evolves -- which is precisely what we saw this past week. Like it or not, the economy proceeds more through Darwinian evolution than "intelligent design." Emergent phenomena and evolution are the norms for the economy. The Fed (and Wall Street) can influence the evolution, of the economy, but not control it as if it were a clockwork machine. Predicting the precise or even general impact of any Fed action or inaction is quite literally a fool's errand. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet." Finally, studies have shown that Fed funds futures are not a very reliable indicator more than 45 days into the future.

What the Fed funds futures market tells us clearly is that the Fed will most likely leave rates unchanged for the next 12 months. The market is not predicting any cuts out as far as Fed futures trade (that I can see), but that is too far in the future for the market to give a reliable forecast.

My feeling is that since the housing retrenchment and so-called subprime "crisis" didn't cause a Fed cut at the January (or March) FOMC meeting, it is unlikely that housing or the so-called subprime "crisis" will be enough of a problem to cause a Fed cut for the rest of the year either.

As of the May 31, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research has become significantly less bearish ans is now forecasting a Fed funds rate of 4.50% by the end of 2007 (versus their previous forecast of 4.00%.) That would be two quarter-point cuts. They continue to forecast a Fed funds rate of 3.75% by the end of 2008. They continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective. It sounds to me that their commitment to their "call" is rapidly crumbling and that they themselves are on the verge of admitting that they are clueless.

Why would the UBS outlook be so far off from my own view or even from the pessimistic market view? The wide divergence of these views doesn't make sense, right? Well, that's true if one were considering only economic fundamentals, but we do need to take into account that UBS has a customer base that they want to preserve and that the "research" document I referenced is really marketing literature, most likely designed to make the existing UBS customer base feel that UBS is "in touch" with their customers and their "needs." That is par for the course with the big financial firms. Step 1 is to understand the hopes and fears and anxieties of your customers and step 2 is to directly tap into those hopes and fears and anxieties. Right now, a lot of people hear so many desperate and gloomy stories in the media and internalize that desperation and gloom, and the result is that firms like UBS have no choice but to send out a message of "we understand and share your fears and anxieties." Better to be wrong and keep your customer base than be right and lose your customers. The bottom line is that individual investors cannot look to the research and economic outlooks peddled by Wall Street for a balanced accurate view of how the conomy and businesses will likely unfold in the coming months or year or over any period of time.

The bottom line here is that the Fed won't move over the rest of the year or even the coming twelve months, and any speculation about Fed moves further down the road are simply wild guesses based on contrived stories about a hypothetical future economy that happens to have a mind of its own.

Why are so many smart people so confused about the future? It is simply the fact that the conservative thing for them to do is to assume that economic events such as housing booms always play out in the same pattern every single time. For a bureaucrat, that is always the safe approach. Alas, every economic episode has its own idiosyncratic pattern and the real issue is how to forecast the interactions between the many sectors and regions of the economy, and that is a really hard problem that is absolutely not amenable to the cookie-cutter application of historical patterns.

The current "herd mentality" on Wall Street is basically sending so many speculators and even investors off on a truly wild goose chase, after which Wall Street will quietly acknowledge its error ("the data changed in an unexpected manner") and then chase those same speculators and investors back in the opposite direction, making sure to collect transaction fees and spreads on both legs of the roundtrip "chase." Expect to see a reversal of the trend of the past week within a month.

Note that the Weekly Leading Index of the Economic Cycle Research Institute is telling us that the economy will be holding together reasonably well for at least the next few months.

-- Jack Krupansky