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Economic data last week were generally negative and Fed officials acknowledged that downside risks for economic growth had increased – that is Fedspeak for the odds for recession are higher. In that context Fed Chairman Ben Bernanke endorsed the idea for a fiscal stimulus plan that was being pushed in Congress and by the Administration. At the same time Bernanke indicated that more interest rate cuts are likely. Both monetary policy and fiscal policy will be double-teaming against the possibility of recession. Meanwhile, inflation remained on the high side and equities tanked.
Equities fell sharply this past week due to mostly weak earnings, subprime concerns, negative economic data boosting recession fears, and due to disappointment over the size of the Bush Administration’s view of a suggested fiscal stimulus package. The week did get off to a good start on Monday, however, as Big Blue, IBM, posted unexpectedly strong earnings and pulled up the Nasdaq and other indices. The worst losses of the week were on Tuesday and Thursday. Equities were pulled down on Tuesday by Citigroup’s announcement of almost $10 billion in subprime related losses and by an unexpectedly weak December retail sales report. Stocks were battered on Thursday by a sharp decline in housing starts being reported for December, a dramatically weaker Philly Fed manufacturing index for January, and by Fed Chairman Bernanke’s congressional testimony on the economy and on a proposed fiscal stimulus package. His endorsement of a fiscal stimulus package was seen as indicating that the economy is weaker than previously believed. The markets also noted that Bernanke indicated that commercial construction is slowing – a factor not previously pointed to by the Fed. On Friday, President Bush gave a general outline for a fiscal stimulus package that would be in the $140 billion to $150 billion range but the equity markets had hoped for more. Overall, the U.S. equity markets this year have fallen below levels seen at the start of 2007.
Last week, major indexes were down sharply: the Dow, down 4.0 percent; the S&P 500, down 5.4 percent; the Nasdaq, down 4.1 percent; and the Russell 2000, down 4.5 percent.
Since year end, major equity indexes are down, having given up the net gains for all of last year. Major indexes are down as follows: the Dow, down 8.8 percent; the S&P 500, down 9.8 percent; the Nasdaq, down 11.8 percent; and the Russell 2000, down 12.1 percent.
Treasury yields tumbled last week with the shorter maturities falling more than 20 basis points. Weakness in yields was due to weak economic data, flight to quality as the stock market sank, and due to increased expectations by a large minority that the Fed will cut the fed funds target rate on January 30 by 75 basis points instead just 50 basis points. The biggest declines in interest rates were on the same days that equities fell the most – Tuesday and Thursday. Rates fell on Tuesday largely due to weak retail sales, Citicorp’s announcement of huge write offs and losses in the fourth quarter. Thursday’s rate declines were due to declines in housing starts and the Philly Fed manufacturing index as well as to Fed Chairman Bernanke’s comments on the need for additional rate cuts. The two-year T-bond is at its lowest yield since 2004.
Treasury yields were down across the yield curve as follows: 3-month T-bill, down 24 basis points, the 2-year note; down 23 basis points; the 5-year note, down 22 basis points; the 10-year bond, down 17 basis points; and the 30-year bond edged down 10 basis points.
Since year end, the 2-year T-note has fallen 70 basis points while the 10-year T-note declined slid 40 basis points.
Oil prices ended last week down significantly due to increased worries over recession. The week, however, started off in the other direction on Monday as forecasts for colder winter weather and violence in Nigeria boosted the spot price of West Texas Intermediate by $1.51 per barrel to $92.69. Prices fell each day for the rest of the week. Declines were sharpest on Tuesday (down $2.30 for the day) and on Wednesday (down $1.06 for the day), reflecting weak economic data on Tuesday and a boost in stockpiles on Wednesday. Recession fears weighed on prices all week.
The spot price for West Texas Intermediate fell $2.42 per barrel net for the week to settle at $90.27 per barrel, $9.35 below the record high of $99.62 set January 2nd.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
This past week was jam packed with economic data, most of which point to a slowing in economic growth and possibly a mild recession. Inflation data improved but remained at a high pace. Are we in recession, yet' While many of last week’s indicators were weak, they actually come close to guaranteeing that 2007 ended without the start of recession – yet.
Much was made in the markets of the stronger than expected drop in retail sales in December. Some cited the numbers as “proof” that we are already in recession. Retail sales fell 0.4 percent, following a strong 1.0 percent gain in November. Indeed, retail sales slowed sharply in December, but there are at least two key points to keep in mind. The decline was far less than the surge seen the month before and that weakness was driven heavily by a drop in gasoline sales. Excluding motor vehicles, sales posted also declined 0.4 percent, after a 1.7 percent jump in November. Sales excluding gasoline slipped 0.2 in December, following a 0.4 percent advance the month before. Excluding both motor vehicles and gasoline, retail sales edged down 0.2 percent in December, after surging 1.6 percent in November.
Taking into account the weakness in gasoline and the robust November numbers, the latest month was hardly a disaster but primarily coming off a strong November. Also, the quarterly averages are strong enough to moderately boost the durables and nondurables components in personal consumption for the fourth quarter and keep real GDP positive for the final quarter of 2007.
Weakness in December was led by building materials, clothing, sporting goods, electronics, and gasoline sales. Most of these categories had strong gains in November. For December, some strength was seen in miscellaneous stores, nonstore retailers, furniture, food & beverage stores, and in health & personal care.
Housing is worse than previously believed and is one of the key reasons that the risk of recession has risen. Housing starts in December fell sharply, dropping 14.2 percent, following a revised 7.9 percent decline in November. Overall permits fell 8.1 percent, following a 0.7 percent dip in November. The latest housing starts report indicates that housing has a long way to go for recovery.
Within starts, weakness in the latest month was led by multifamily units. Single-family starts in December declined 2.9 percent after a 6.9 percent fall in November while multifamily starts posted a sharp 40.3 percent drop after a 10.1 percent decline in November.
Seasonal issues may have played a role in December’s weakness as suggested by the regional data. Declines were strongest in the regions with the worst winter weather. Regionally, in December declines were led by a 30.8 percent fall in the Midwest, with declines also seen in other regions. Starts in the Northeast were down 25.8 percent; the South, down 3.3 percent; and the West, down 19.6 percent. Seasonally adjusted data are very sensitive to small changes in actual, unadjusted numbers during winter months because the seasonal factors are so large during these months.
Permits did not decline as much as starts in the latest month. Overall permits declined 8.1 percent, following a 0.7 percent drop in November. Within housing permits, single-family permits fell 10.1 percent while multifamily permits decreased 4.1 percent. Because permits are not as weather sensitive as starts (going into an office versus actual on-site activity), the smaller decline in permits also suggests that some of the December drop in starts was related to weather and seasonal factors.
On a year-on-year basis, overall starts were down 38.2 percent in December while permits were down 34.4 percent.
Whether or not weather and seasonal factors overstated the softness in starts, they still clearly are in depression and the numbers do not bode well for homebuilders. Also, they point to greater than expected weakness in coming months for spending on consumer durables such as household appliances, carpeting, and even televisions.
Another indicator that suggests the economy stayed out of recession at the end of the year is industrial production. Markets had expected a negative number for the final month of the year but it came in flat. Overall industrial production was unchanged in December, following a 0.3 percent boost in November. The manufacturing component also was unchanged in December, following a 0.3 percent advance in November. Utilities output declined 0.2 percent while mining output increased 0.1 percent.
The industrial production report included some favorable news on the inflation front. Overall capacity utilization decreased to 81.4 percent in December from 81.6 percent in November. The capacity utilization rate for manufacturing came in at 79.7 percent in December, incrementally down from 79.8 percent in November. Both overall and manufacturing utilization rates have been on a moderate downtrend, pointing to some easing in resource utilization which reduces inflation pressures to some degree.
The Empire State manufacturing survey is indicating a slowing in manufacturing while the Philly Fed survey is pointing to an outright decline. Meanwhile, prices are firming. From the Empire State survey, the main index was little changed at 9.0 in January compared to 9.8 in January. The Philly Fed’s business activity index plunged to minus 20.9 in January from an already soft minus 1.6 in December. The Philly index suggests that manufacturing may be entering a period of decline during the first part of 2008.
New orders indexes for both surveys also indicate a potential decline in coming months. For the Empire State survey, the new orders index fell to zero from 13.2 in December.
Price data are taking a turn for the worse in both surveys and for both prices paid and prices received. In the Empire State survey prices paid rose to 40.2 in January from 35.0 the month before. The Philly Fed survey’s prices paid index soared to 49.8 in January from 36.5 in December
Output prices were up, also. From the Empire State survey, the prices received index rose to 18.3 in January from 12.5 the prior month. Upward pressure was even stronger in the Philly survey as output prices spiked to 32.0 from 15.2 in December. However, output prices may come under downward pressure as output softens.
The Fed says it is setting monetary policy based on its forecasts and how incoming data corroborate or not those projections. And the latest CPI and PPI numbers certainly must be challenging the Fed’s confidence in having high actual inflation come down to match its forecast for lower inflation in coming quarters. The overall consumer price index in December rose 0.3 percent, moderately strong but coming off the 0.8 percent spike in November. For December, the core CPI inflation rate increased 0.2 percent, after firming to 0.3 percent in November.
Once again, higher energy prices kept the overall CPI on the high side in December. In the non-expenditure category for energy, prices increased 0.9 percent, following a 5.7 percent surge in November. By expenditure category, on the high side in December were transportation, up 0.5 percent; medical care, up 0.3 percent; education & communication, up 0.3 percent; "other," up 0.3 percent; and housing, up 0.3 percent. Within housing, owners' equivalent rent held steady at 0.3 percent. By expenditure category, on the soft side were food & beverages, unchanged; recreation, unchanged; information, unchanged; and apparel, up 0.2 percent.
But the trend for inflation is not good. In contrast to a slowing in inflation in mid<%Response.Write("- "&Year(Now())) %>., inflation at the headline and core levels ended the year with significant uptrends. Year-on-year, the overall CPI eased to up 4.1 percent in December from up 4.3 percent in November. The core rate firmed to up 2.4 percent in December on a year-on-year basis from up 2.3 percent in November. The headline rate was the highest year-on-year rate in 17 years for the last month of the year.
How do the latest numbers compare to Fed expectations' While the Fed does not publicly forecast the CPI, it does have forecasts for PCE inflation. The PCE price index inflation tends to run about a quarter percentage point lower than CPI inflation due to differences in how they are constructed.
The overall CPI ended 2007 with a 4.1 percent pace (December over December). If about a quarter percentage point is sliced off to make comparable to PCE inflation, then overall consumer inflation came in at about 3.8 percent which is 1-3/4 percent over where the Fed wants to be – 1-1/2 to 2 percent PCE inflation. The core CPI ended 2007 at 2.4 percent or about 2.1 or 2.2 percent if adjusted to be on a PCE basis. This is closer to the Fed’s comfort zone and the Fed is counting on weak economic growth to pull core inflation within a 1-1/2 to 2 percent band.
Overall producer prices in December edged down while the core rate moderated. This is good news on the inflation front. The overall PPI slipped 0.1 percent in December, following a 3.2 percent surge in November. The core rate moderated to a 0.2 percent increase, following a 0.4 percent jump in November. For the overall PPI, the December decline was led by the energy component, which fell 1.9 percent, following a 14.1 percent monthly surge in November. December's headline number and core number were both pulled down by passenger cars and light trucks which declined 0.9 percent and 0.3 percent, respectively.
The year-on-year rate for the overall PPI dropped to up 6.8 percent in December from up 7.7 percent in November. The year-on-year core rate firmed to up 2.1 percent in December from up 1.9 percent in November.
The Beige Book prepared by regional Fed banks for the upcoming January 29-30 FOMC meeting indicated that the overall economy continued to grow “modestly” although results were mixed by Fed District. While this report is “bluer” than any recent reports, the report does not suggest that the economy is in recession. The report is based on information collected before January 7.
Of the 12 districts, “seven reported a slight increase in activity, two reported mixed conditions, and activity in three Districts was described as slowing.” The Beige Book reported “subdued” holiday spending, suggesting some softening in the consumer sector. Auto sales were weakening. A bright spot in the retail sector, however, is that tourism and purchases of goods by foreigners have picked up. Numbers of tourists from Canada and Europe were especially strong.
The Beige Book sees housing as still depressed. However, commercial construction was reported to be softening – a new development. Manufacturing activity was “varied.” While housing and auto-related manufacturing were soft, strength was reported for aircraft, information technology, defense, and energy-related manufacturers.
Inflation reports were mixed but mostly on the high side with food and energy costs being key concerns. Transportation costs have been more of a problem for many industries. Labor markets generally were still seen as tight, especially for skilled workers. But employment costs were mostly described as moderate except for the energy sector which cited significant wage pressure.
Overall, the Beige Book reports an economy that is within the Fed’s expectations on the real side but a little higher on the inflation front.
Fed Chairman Ben S. Bernanke on Thursday of last week give his views on "The Economic Outlook" before the Committee on the Budget, U.S. House of Representatives and endorsed the idea of using fiscal stimulus to keep the economy from slowing too much. Bernanke acknowledged that the outlook for the economy has worsened and that downside risks to economic growth have become "more pronounced." For the first time, he mentioned that business investment is slowing. While the Fed Chairman sees real growth as weaker, he was concerned about higher inflation recently which is due to higher food and energy costs as well as a lower dollar and other factors.
Regarding any fiscal stimulus from Congress, he stated that any stimulus package should be "implemented quickly" and "felt as much as possible within the next 12 months or so." He called a stimulus package of $100 billion as being significant. Getting money to low income and middle income families would result in more "bang for the buck" from the stimulus. Bernanke emphasized that the majority of the impact should be felt quickly with the vast majority of the cumulative impact occurring within a 12 month time frame.
While most of his discussion was about fiscal stimulus, Bernanke did confirm that given current conditions that additional interest rate cuts may be needed.
Despite acknowledgement that downside risks on economic growth have increased and that near term interest rate cuts are coming, Chairman Bernanke echoed comments of other Fed officials that inflation is still a concern.
"However, any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank's policy flexibility to counter shortfalls in growth in the future. Accordingly, in the months ahead we will be closely monitoring the inflation situation, particularly inflation expectations."
Once lower interest rates and fiscal stimulus get the economy back on track, the Fed may be quickly resuming interest rate increases.
At the end of last week, President George Bush outlined his views on the broad characteristics of what pending fiscal stimulus should look like. He reiterated much of what Fed Chairman Bernanke stated and added some of his own points. Bush stated that the fiscal stimulus is needed as a “shot in the arm” to keep a fundamentally healthy economy strong. Bush stated that the fiscal stimulus should be big enough to have an impact on GDP. He calls for stimulus equal to 1 percent of GDP. He stated that the stimulus should be temporary and take effect immediately. He wants the fiscal stimulus to be enjoyed by both consumers and businesses. He sees tax rebates for consumers and tax incentives for businesses. The incentives for businesses should result in immediate spending on business investment.
Treasury Secretary Henry Paulson added a few more points to the president’s outline. He said the stimulus package should not affect the long-term deficit. He sees the size of the stimulus package in the vicinity of $140 billion to $150 billion. Interestingly, these numbers are higher than proposals put forth by some of the presidential candidates. By the time Congress and the administration finalize the legislation, there is a good chance the package will be even higher due to usual election year posturing by the parties.
Treasury Secretary Paulson stated that speed is important and that there are benefits of simplicity. The biggest portion should be for tax relief. He believes that the stimulus package would result in the creation of “half a million” jobs that would not have been created otherwise.
A potential area for disagreement between the administration and Congress is what income range the consumer portion of the stimulus targets. The administration wants the rebates to be “broad based.” Congress may want to target the middle class and give little or nothing to high income tax payers. While this is a political decision, economic studies are consistent and clear that the highest spending impact would come if the stimulus package for consumers did not include high income tax payers but focused on low income or low and middle income consumers.
The administration last week was careful to not mention any numbers for how large the rebate checks might be. But the numbers that were heavily kicked around in the media were $800 per tax payer or $1,600 per taxpaying household. Speculation was that at the earliest it would be March or April before consumers could be receiving rebate checks.
In case you got caught up in the talk about Bernanke’s and the administration’s views on fiscal stimulus, there still were some other Fed officials making the rounds on the speaking circuit. Both Federal Reserve Bank of Cleveland Sandra Pianalto and Federal Reserve Bank of Richmond President Jeffrey M. Lacker gave their views on the economy. Both saw increased downside risks to economic growth but both also saw inflation as more worrisome than in recent months.
Pianalto stated, "Even as economic growth was slowing, inflation at year-end was clearly elevated. Rising energy prices were a big part of the increase in overall inflation, and some of those costs were passing through to the core inflation measures as well. So, too, the falling dollar seems to have boosted import prices. But I continue to believe that the economy's inflation trend will move lower over the forecast horizon as the growth rate of the economy slows and the influence of energy and import prices diminishes."
Lacker has a generally mainstream forecast for this year with housing still depressed, the consumer sector slowing, moderating business investment, and robust exports. While Lacker sees "very weak" growth in the near term, he does not rule out the possibility of recession.
Like Pianalto, Lacker also is worried about inflation.
"I am also troubled by the lengthy divergence we've seen between overall and core inflation. Some of you may recall that core inflation was devised in the 1970s to filter out some of the more volatile consumer prices to get a better read on inflation trends. For several decades, core inflation seemed to work well due to the fact that food and energy prices had no clear trend relative to the overall price level. In the last few years, though, overall inflation has been persistently above core inflation, and few observers expect oil prices to go back below $20 per barrel. Because the job of a central banker is to protect the purchasing power of currency, it is overall inflation that we need to keep down, not just core inflation."
The bottom line is that the views of both support a sizeable rate cut on January 30. But their worries about inflation suggest that interest rates may make a U-turn back up later in the year – especially if fiscal stimulus kicks in by mid-year.
Economic data point to a flat economy in the first quarter of 2008. But lower interest rates and expectations of fiscal stimulus could put the economy back on track by the second quarter.
This holiday shortened week is almost devoid of economic indicators. All markets in the U.S. are closed on Monday for the Martin Luther King, Jr. Holiday. The only notable economic data come out on Thursday with jobless claims and with existing home sales.
Martin Luther King, Jr. Holiday. All markets in the U.S. are closed.
Initial jobless claims fell 21,000 in the week ending January 12 to 301,000, the lowest level since September. There were no special factors in the week. But the improvement was not confirmed by continuing claims which shot up 66,000 to 2.751 million in data covering the week ending January 5. Continuing claims, again in contrast to initial claims, are at their highest since November 2005.
Jobless Claims Consensus Forecast for 1/19/08: 321,000
Range: 300,000 to 330,000
Existing home sales in November edged up 0.4 percent to a 5.00 million annual rate. But the month-to-month gain masks weakness in the data as the level is the second lowest in the nine years of the current series. Supply on the market, though still bloated, slipped to 10.3 months in November from 10.7 months in October. Prices remain firm, rising 1.6 percent to $210,200, down only 3.3 percent year-on-year. But the median price is likely overstating how well prices are holding up, given that the low end of housing is likely weaker than other segments. Continuing softness in consumer confidence and tighter lending standards suggest another near record low pace in December.
Existing home sales Consensus Forecast for December 07: 4.95 million-unit rate
Range: 4.90 to 5.10 million-unit rate
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