10 Year Note

The U.S. economy's failure during 2002 to respond to the Federal Reserve's aggressive easier monetary policy in 2001 ultimately forced the Fed to ease further in 2002; by yearend short term interest rates were at a forty year low, suggesting that the Fed had little leeway to further prime the economy. Indeed, comparisons were made between the U.S. and Japanese economies, with the latter economy basically at a negative return to short-term capital and still their recovery is elusive. However, the comparison is probably unwarranted owing to key banking and political differences between the two countries. So what went wrong in the U.S.? The answer is elusive, if not more fittingly--unknown. The Fed's easing during 2000-01 had a dual purpose: 1) to try and prevent and/or minimize slippage in the economy and 2) to correct the restrictive monetary policy of late 1999 and early 2000 which may have helped set the stage for the economy's subsequent weakness. Typically, Fed action takes about six months to filter into the economy, i.e. that the easier policy that began in January 2001 should have seen a buoyant effect taking hold by mid-summer: it didn't happen although partly owing to factors that were beyond the Fed's scope to control or anticipate. However, it could also reflect a sense that Fed policy lost its time-tested clout in 2001-02. The U.S. economy officially slipped into a recession in the first quarter of 2001, ending a near ten-year record setting run of economic growth, but in the months that followed the recovery proved anemic. Although there was no official recession in 2002, unemployment at yearend was at 6%, the highest since the early 1990's. On the positive side was continued low inflationary pressure during 2002; the CPI for the year rising 2.4% vs. 1.6% in 2001. Also the housing industry was robust with 30 year fixed rate mortgages under 6% in late 2002. The automotive industry also had a pretty good year as manufacturers offered myriad financial incentives, including zero financing for qualified buyers. Although yearend holiday sales were disappointing the U.S. consumer supported the economy during the year as corporate America maintained a low capital investment profile and where possible, low inventories. The diversity between corporate and consumer approaches was unusual considering the Fed's eleven cuts in short term rates during 2001, a single cut in 2002 and talk of further fiscal stimulus in 2003. Some underlying change in the U.S. economy's structure may have taken root. If it has, is it deep or shallow rooted?