Insight Line—September 17, 2007

When Federal Reserve Chairman Ben S. Bernanke noted that policy makers at the Federal Open Market Committee (FOMC) were elevating the importance of real-time data to monetary policy deliberations, investors already knew where to focus: the short-term credit markets. After all, interest rates on AA commercial paper—a crucial source of short-term funds (see accompanying chart)¹—had uncharacteristically shifted markedly from their historically normal levels.

How investors evaluate and respond to risk has long been a focus of economists and academics.

Accordingly, much consideration has been given to discovering the potential information contained in risk premiums, which are, in essence, the additional potential returns demanded by investors to hold anything but the most secure investments.

The FOMC, of course, is no stranger to the analysis of risk premiums. In July 2005, FOMC Governor Donald L. Kohn gave investors a candid look at how the FOMC factors real-time market pricing and risk premiums into policy deliberations. Stated Kohn, “Among the risk premiums that we monitor regularly at the Federal Reserve are those on equity returns, equity volatility, corporate bonds, and Treasury securities.”² He went on to say, “Neglecting or grossly misestimating risk premiums will lead to misperceptions of the market’s outlook and thus potentially to market moves that we did not anticipate.”³

Granted, while incoming economic information remains key to policy deliberations, such data by definition tells us what was, not what is. As such, as the recent turn of events in the nation’s commercial paper markets demonstrates, I believe the likely course of future monetary policy actions from the FOMC has as much to do with economic statistics as it does with watching the spreads in the nation’s credit markets.

¹ Ned Davis Research, Chart b0124a, 30-Day AA Commercial Paper Spreads, Financial, Non-Financial and Asset Backed, date range 09/0602005-09/06/2007, ©2007, Ned Davis Research, Inc.

² Kohn, Donald L., “Monetary Policy Perspectives on Risk Premiums in Financial Markets,” Remarks by Governor Donald L. Kohn, at the Financial Market Risk Premiums Conference, Washington, D.C., July 21, 2005, page 1.

³ Kohn, page 2.

This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information in this report does not pertain to any Van Kampen product and is not a solicitation for any product.

Factors Driving the Economy

Economic Acceleration

Economic Deceleration

Latest Available Information
(as of 09/14/07

Employment
^{(Source: Bureau of Labor Statistics)}

Up

Down

The August 2007 employment data was nothing short of a surprise to economic forecasters. The headline loss of 4,000 payroll jobs along with 316,000 in the broader household survey gave many investors reason to discuss the potential makings of an economic recession. While the data is disconcerting, it also comes at a point in the calendar year that has historically presented the Bureau of Labor and the Census Bureau with a daunting challenge. The back-to-school, summer employment and auto production shifts arguably mask any real knowledge on the state of the labor market. That said, no change in the unemployment rate and hours worked, and a slight gain in the wage data suggests the underlying employment trend remains near levels associated with full employment. As such, I suggest the appropriate action on the table is to circle Up.

Personal Income
^{(Source: Bureau of Economic Analysis)}

Up

Down

July’s 2007 personal income data registered a stronger than expected increase of 0.5 percent. The annualized total of $11.7 trillion is a record level. Wage and salary totals, at $6.4 trillion, are also a record high. As such, I believe personal income data remains supportive of economic activity in the coming months. Please circle Up on the table.

Retail Sales
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

August 2007 retail sales data, encompassing the bulk of back-to-school shopping, is often a harbinger of the upcoming holiday season. August’s surprisingly weak showing of up 0.3% and -.4% ex-autos suggests concerns over the recent housing data having an adverse affect on consumer spending, appear warranted at this time. Though the data is always subject to revision this release merely confirms the trend noted in Factors months ago. The open question is whether this data is foreshadowing a lackluster holiday shopping season. I do not believe that to be the case as the current month’s data appears to have some statistical anomalies. Nevertheless, I continue suggesting the appropriate circle on the chart remains Down.

Durable Goods
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

Durable goods orders for July 2007 remained true to recent trends suggesting moderate but continuing strength in the nation’s manufacturing sector. New orders, inventories, shipments and unfilled orders all registered positive gains. As such, concern I expressed last month on the viability of an expanding manufacturing sector have lessened, but not enough to shift the preferred circle to up. Therefore, I am leaving Down as the preferred circle of choice.

Inflation
^{(Source: Bureau of Labor Statistics)}

Low

High

Inflationary pressures remain evident but not elevated. The Federal Reserve’s preferred measure, Personal Consumption Expenditures ex food and energy price changes, as of July 2007 rested at 1.9 percent year-over-year. Inflation, though within the acceptable range for some members of the Federal Open Market Committee (FOMC), has yet to demonstrate to some FOMC members its ability to remain within accepted targets. Therefore, in accordance with the FOMC’s elevated concerns, I suggest, but do not heartily support, circling High on the chart.

Government Spending
^{(Source: Congressional Budget Office, U.S. Treasury)}

Up

Down

With only one month remaining in fiscal 2007 the U.S. federal budget prospects are the brightest in years. Early forecasts of a $400 billion fiscal 2007 deficit have proved wide of the mark, as tax receipts – despite rising federal budgets – far exceed expectations. That said, the budget deficit does remain a feature on the investment horizon for months and years to come. As such, the federal government continues to stimulate economic activity with deficit expenditures thereby making the appropriate circle on the chart Up.

Monetary Policy
^{(Source: Board of Governors, the Federal Reserve System)}

$In

$Out

The FOMC held the overnight inter-bank lending rate at 5.25 percent. Recent developments in the nation’s credit markets and an unexpected decline in payroll employment raise the strong likelihood of at least a 25 basis point reduction in the federal funds rate within the days following this commentary. Additionally, I expect the FOMC to adopt a bias toward increasing bank reserve availability for the remainder of the year. Therefore, please continue to circle $In.

Yield Curve
^{(Source: Bloomberg, LP)}

Positive

Negative

The difference between the three-month Treasury bill yield and the 10-year Treasury note yield note yield was 49 basis points on September 14, 2007. Please Circle Positive.

Gross Domestic Product
^{(Source: Bureau of Economic Analysis)}

Above

Below

The nation’s GDP in the second quarter recovered smartly from the 0.6 percent annualized growth in the first quarter. The annualized rate of 4.0 percent came about as government and business spending surged. Net exports were also a surprising source of strength. Nevertheless, anecdotal evidence in the third quarter activity calls into question the sustainability of the last quarter’s growth. Housing and government spending do not appear to be as strong. Consumer and business spending, while not retreating from second quarter’s levels, show few signs of advancing. Exports appear to be the only bright spot on the horizon, but may not represent a strong enough offset to the continued drag on growth from residential housing. Therefore, I continue positioning the appropriate circle as Below.