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Generally weak economic data and record high oil prices pulled the rug out from under stock prices. A number of equity indexes hit lows not seen in two years or more. For the economy, there is good news and bad news. The good news is that is looks like we were not in recession at all during the first half – though we likely did not miss by much and it certainly felt like recession. The bad news is that the combination of sluggish growth and high headline inflation is not likely to go away soon.
Equities continued to swoon last week. Stocks were hard hit by further gains in oil prices (including a new record high topping $140 per barrel), a deteriorating outlook for banks and other financial firms, and downgrades on economic growth due to concerns over the consumer sector and housing weakness.
Higher oil prices were seen weighing on not just the consumer sector but also on businesses in general, raising costs and reducing profits. Financial firms were under heavy downward pressure as credit losses were seen carrying into 2009, both from housing, consumer credit, and business difficulties. The consumer sector is seen as continuing to soften as both the Conference Board and Reuter’s/University of Michigan indexes fell to near record lows. While home sales were mixed, markets focused on another drop in the Case-Shiller home price index, which indicated that the housing sector remains very distressed.
There was some temporary relief last week on Wednesday after the Fed released the FOMC announcement indicating no change interest rates, which gave some relief to traders worrying that the Fed might actually raise rates. Stocks liked the Fed stating that risks to downside economic growth had diminished. Equities also got a temporary lift from lower oil prices for the day after a reported rise in U.S. stocks.
But stocks tumbled sharply on Thursday with index declines for the day ranging from 2-1/2 to 3-1/2 percent. Several factors converged to pummel the markets. Oil prices traded over $140 per barrel for the first time, financial firms were downgraded by analysts, GM shares plunged after the company was downgraded, and techs fell after Research in Motion fell sharply short of earnings expectations. Equity losses continued on Friday as oil traded over $140 per barrel throughout the day and settled above that mark for the first time. Financials fell notably after analysts increased their estimates sharply of subprime writedowns.
The Dow ended the week just a fraction less than 20 percent down from its all-time high set in October. A 20 percent drop from the latest high is considered by many to define a “bear market.”
Last week, major indexes were down as follows: the Dow, down 4.2 percent; the S&P 500, down 3.0 percent; the Nasdaq, down 3.8 percent; and the Russell 2000, down 3.8 percent.
 Equities are poised to have heavy losses for the month of June. Through this past Friday, monthly losses were: the Dow, down 10.2 percent; the S&P 500, down 8.7 percent; the Nasdaq, down 8.2 percent; and the Russell 2000, down 6.7 percent.
For the year-to-date, major indexes are down from year end as follows: the Dow, down 14.5 percent; the S&P 500, down 12.9 percent; the Nasdaq, down 12.7 percent; and the Russell 2000, down 8.9 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury rates fell notably this past week despite a further run up in oil prices. Economic weakness and flight to safety were the key factors for rates easing. On economic data, markets focused on a further drop in home prices, depressed new and existing home sales, two very anemic consumer confidence reports, and soft durables orders.
Flight to quality took place just about all week but especially on Thursday as the stock market fell sharply. Additionally, much higher estimates being announced for subprime credit losses also spooked funds from private bonds to Treasuries. Downgrades to bond insurers also made Treasuries more attractive.
 However, at mid-week, Treasury rates did firm right after the Fed’s FOMC statement which pointed to pending rate hikes. But a market re-evaluation of the announcement decided that the economy is still too weak for the Fed to boost rates anytime soon.
On the week Treasury rates were down as follows: 3-month T-bill, down 19 basis points, the 2-year note, down 25 basis points; the 5-year note, down 24 basis points; the 10-year bond, down 20 basis points; and the 30-year bond, down 20 basis points.
Rates have headed back down over the past two weeks – weighed down primarily by flight to quality and an increased realization that the economy is not likely to rebound as strongly in the second half as many had hoped.
 Oil prices skyrocketed again despite a modest rise in stockpiles. Spot prices for West Texas intermediate surged over $4 per barrel per day on both Thursday and Friday to settle at a new record high of $142.31 per barrel. The previous record of $138.54 had been set on June 6.
Factors boosting prices were a strike by oil workers in Nigeria, attacks by militants on oil facilities in Nigeria, saber rattling between the U.S. and Iran, and unsettling remarks by Middle Eastern officials. Notably, Libya announced that it is considering cutting oil production in retaliation for enactment ofa U.S. law permitting certain terror victims to seize asserts of the Libyan governments as compensation for Libyan-linked terrorist acts. Additionally, an OPEC official claimed that the price of crude could reach $170 per barrel by end of summer. A selloff of equities on both Thursday and Friday also boosted prices both days as many investors saw oil as a safe haven. Throughout the weak, a soft dollar and continued strong demand for oil overseas support oil gains.
Net for the week, spot prices for West Texas Intermediate jumped $7.69 per barrel to settle at $142.31.
This past week, the economic news was not inspiring – with the possible exception of parts of the personal income report. Meanwhile, manufacturing was flat, housing was still depressed but possibly leveling off, and the Fed ended a nine month string of interest rate cuts and even hinted that it was thinking about when to start raising rates.
 Well, it is official – we dodged recession in the first quarter. The final revisions to first quarter GDP showed the economy marginally better than previously estimated as GDP growth was revised up to an annualized 1.0 percent from the prior estimate of 0.9 percent.
But headline inflation has been heating up, going back the last two quarters. The first quarter GDP price index was revised up marginally to an annualized 2.7 percent from the previous estimate of 2.6 percent. Headline PCE inflation was nudged up to 3.6 percent from 3.5 percent while core PCE inflation was boosted to 2.3 percent from the prior estimate of 2.1 percent.
 The bottom line is that GDP growth was clearly above a recession pace but inflation was picking up. The latest revisions to GDP confirm the view that the economy is in mild stagflation.
 The latest personal income report completely surprised the markets with its strength in income growth and spending. But the underlying trends are not too different from recent months as the one-time income tax rebate checks were largely responsible for the income boost while higher gasoline prices created much of the stronger spending. Personal income in May jumped 1.9 percent, following a 0.3 percent rise in April. The increase in May was the largest since the 3.2 percent surge for September 2005 when Katrina-related insurance payments boosted personal income. For the latest month, the federal government issued rebate payments of $48.1 billion ($577.1 billion at an annual rate) and $1.9 billion in April ($23.3 billion at an annual rate).
While the huge gain from income tax checks is important, a rebound in wages and salaries actually should be more comforting since it is the trend in wage growth that sets the trend for spending. The wages and salaries component rebounded 0.3 percent, following a 0.1 percent dip the month before.
On the spending side, personal consumption soared 0.8 percent in May after rising 0.4 percent in April. But a sizeable part of the spending gain was inflation related as spending was led by a 1.2 percent boost in nondurables which includes gasoline. Durables slipped 0.2 percent while services posted a 0.7 percent gain.
 Higher gasoline prices are having a very negative impact on headline inflation as the headline PCE price index worsened to 0.4 percent in May from 0.2 percent the month before. However, the core PCE price index was unchanged at 0.1 percent in May and came in better than the consensus expectation for a 0.2 percent rise. Year on year, headline PCE inflation came in at 3.1 percent while that for the core was 2.1 percent.
What happened to the income in May that was not spent – that is, income shot up far more than spending' Consumers saved some of that money as the personal saving rate jumped to 5.0 percent from 0.4 percent in April. What this means is that consumers still have some of the rebate checks left over to spend in coming months. Even if some of it ends up in gas tanks, the money is helping consumers to transition to higher gasoline prices and not just retrench.
Putting the personal income report into the big picture for the economy, real personal consumption posted a healthy 0.4 percent gain, following a 0.2 percent increase the month before. The spending in May was quite good in real terms despite higher gasoline prices. This gives second quarter GDP a good foundation for modest growth, providing good evidence that we will avoid recession throughout the first half of the year.
 Certainly the durable goods orders series is volatile. But the trend over the last few months shows total new orders trending slightly negative. Most recently, durable goods orders were unchanged in May, following a 1.0 percent drop in April. However, excluding the transportation component, new orders fell back 0.9 percent, following a 1.9 percent surge in April.
Strength in overall orders was led by transportation with a 2.6 percent partial rebound, after an 8.3 percent fall the month before. For the latest month, defense aircraft rose 14.9 percent, nondefense aircraft increased 10.3 percent, and motor vehicles slipped 3.3 percent. Gains were also seen in fabricated metals, computers & electronics, and electrical equipment. Weakness for the latest month was in machinery, down 5.3 percent; primary metals, down 1.3 percent; and “other,” down 0.4 percent.
Nondefense capital goods orders are still soft despite a May comeback. These orders rose 0.4 percent in May but followed a 2.4 percent drop the month before. Businesses appear to be moderating their investment plans and these numbers point to a softening for the producers’ durable equipment component within GDP.
While new orders have turned slightly negative on average in recent months, unfilled orders have continued to rise, providing support for actual production. Unfilled orders for durable goods rose 0.9 percent in May after a 0.7 percent boost the month before. But momentum is slowing as unfilled orders on a year-ago basis stood at 15.8 percent in May, compared to a recent high of 19.5 percent in August 2007.
 The latest numbers on home sales show new home sales declining while existing home sales edged up. Both series are at lows not seen in over a decade or more. New homes sales showed a 2.5 percent month-on-month decline in May to an annual adjusted unit sales rate of only 512,000. Sales levels were this low back in the early 1990s and during the recessions of the 1980s and 1970s. But current numbers are even worse when taking into account that prior weak levels were based on smaller populations than today. The year-on-year decline for May stood at 40.3 percent.
New home prices, which have held in better than prices for existing homes, are finally beginning to give in, dropping 5.1 percent in the month to a median $231,000 which is down 5.7 percent year-on-year.
In contrast to new homes, sales of existing homes actually rose 2.0 percent in the month to a 4.990 million annual rate, the best rate since February and the second best rate since November. The year-on-year contraction eased more than 1 percentage point to 15.9 percent, much better than the 40 percent contraction for new home sales (data released Wednesday). Supply remains badly swollen but a little less so in May at 10.8 months vs. 11.2 months in April.
Price readings were positive especially given the size of supply. Both the median and average prices showed solid low single digit month-to-month gains with year-on-year contraction easing more than 1 percentage point to 6.3 percent for the median ($208,600) and 6.5 percent for the average ($253,100). However, the firming in prices may merely reflect higher end homes picking up a bigger share of sales than lower end homes.
 Despite a boost in income from tax rebate checks, consumers are in a gloomy mood. Consumer confidence is unusually low, at its fifth all time worse reading in 40 years of Conference Board data. The Conference Board's consumer confidence index literally plunged in June, down nearly 8 points to 50.4. The expectations component is at a record low of 41.0, down more than 7 points, with the present situation at 64.5, down nearly 10 points for its worst reading since the early part of the ongoing expansion in 2003.
The Fed certainly took notice of a continued high reading on inflation expectations at 7.7 percent for one year out. Inflation worries appear to be leading consumers to adopt an almost bunker mentality looking forward. Buying plans for cars fell further while home buying plans are steady at record lows.
The Reuters/University of Michigan consumer sentiment index gave similar results to the Conference Board numbers. This index slipped further in the final June report, to 56.4 for a 3 tenth dip from mid-month and a 3.4 point drop from May. This is the third lowest reading for the series which goes all the way back to 1952 (lowest readings are 52.7 April 1980 and 51.7 May 1980).
Inflation expectations remain high, coming in at 3.4 percent one year out and 5.1 percent five years out.
The bottom line is that consumer attitudes have become much more pessimistic, which will likely make consumers more cautious in their spending over coming months. Also, inflation expectations are showing signs of becoming unmoored – a problem of key concern to Fed officials worried about a rise in trend inflation.
 The Fed ended its string of interest rate cuts with this past week’s FOMC statement. The fed funds target rate has been cut from 6.25 percent in August 2007 to the current 2.00 percent. While we have only had one FOMC meeting with no change in the target rate, the FOMC is already hinting that a boost in rates is not far down the road. A key question is when is the Fed likely to start raising rates'
Fed officials have increasingly been warning that they are concerned about rising inflation pressures – and they have made such statements in the context that financial markets have stabilized to a large degree and that the risks of weak growth have diminished. The latest FOMC statement confirms recent Fedspeak toward greater concern about inflation.
While the FOMC kept the fed funds target rate at 2.00 percent and the the discount rate at 2.25 percent, the vote was not unanimous as Dallas Fed President Richard Fisher voted against with a preference for raising the fed funds target. The vote was 9 to 1 in favor of no change. While the FOMC sees risks for both too low growth and for too high inflation, the Fed has further shifted its concern to be more about inflation than about recession. While the Fed is keeping its options open about the timing of any change in monetary policy, the statement suggests that the Fed is preparing markets for a rise in interest rates sometime in the not far off future.
In the statement, the Fed gives a concise picture of its economic outlook. The FOMC expectations are for continued soft economic growth with an easing in inflation. Sluggish growth is related to a soft labor market and other oft-cited factors.
“Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.”
But even as the Fed anticipates a slowing in inflation, higher prices still are the statement’s key concern.
“The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.”
Current inflation data indicate that inflation is too high relative to the Fed’s implicit target range of 1.5 to 2.0 percent for PCE price indexes. Year-on-year, the headline PCE price index is at 3.1 percent for May while that for the core is 2.1 percent.
 Additionally, some FOMC members in recent speeches have noted that current monetary policy is extremely loose based on real interest rates. By some measures, the real fed funds rate is somewhere between zero and minus 1.
But the economy is likely more sluggish than many have come to believe. The Fed is likely closer to understanding this and will likely end up staying in a pause mode longer than implied by recent hawkish rhetoric. Realistically, the Fed will see little reason to raise rates until after November elections (the Fed actually likes to become “invisible” during presidential elections when possible) and even likely not until early 2009.
While the Fed is now thinking about when to start raising interest rates to contain inflation, the actual next move up is likely months away.
 Market views on future Fed policy changes have changed dramatically since this past spring. During mid-March, the credit crunch was still in full swing and traders in fed funds futures saw little chance for higher rates any time soon. But financial markets have stabilized somewhat and traders have boosted the odds for rate increased to start late this year. However, traders have eased back off of their initial reactions of this past Wednesday. Wednesday’s focus was the hawkish anti-inflation text in the FOMC statement. By Friday, traders had decided the economy is still too weak for aggressive tightening.
Once again, the economic data are pointing to mild to moderate stagflation in coming months. While the Fed is now worrying more about inflation, the real economy is likely to be soft enough the rest of the year that the Fed will not be in a hurry to raise rates.
The holiday shortened week has the highlights on Thursday with the employment situation for June as the Independence Day celebration on Friday bumped the release date up a day. The only other market moving indicator is the ISM manufacturing index out on Tuesday.
The NAPM-Chicago purchasing managers' index improved in May, rising to 49.1 from 48.3 in April. Strength was led by new orders which rose more than 3 points to 56.1 indicating that significantly more firms in the area enjoyed a month-to-month increase than a decrease. Backlog orders improved, becoming less negative with a reading of 46.8 and snapping three straight months in the 30s range. Production showed a month-to-month increase at 51.5, while contraction in employment slowed to 41.2 from April's dismal 35.3 reading. But inflation news was very bad as prices paid jumped to 87.5 in May from 82.9 the month before.
NAPM-Chicago Consensus Forecast for June 08: 48.0
Range: 47.0 to 51.0
The Institute for Supply Management's manufacturing index also may be stabilizing near the break-even point as this ISM index rose 1 point in May to 49.6. New orders were little changed at 49.7 but up nicely from the 46.5 level in May that was indicating contraction. Exports were the main driver for orders, which was up 2 full points to a 59.5 level that easily leads all components. Employment remained weak, little changed at 45.5, indicating yet further month-to-month contraction. As other manufacturing surveys have been reporting, prices paid are astronomical, jumping to 87.0 from 84.5 in April, indicating that all but a small percentage of purchasers are reporting month-to-month increases in the prices they pay for raw materials.
ISM manufacturing index Consensus Forecast for June 08: 48.7
Range: 47.0 to 49.6
Construction spending contracted further in April, dropping 0.4 percent after a 0.6 percent decline in March. The April decrease in construction spending was led by a sharp 2.3 percent fall in private residential outlays with public spending also down 0.3 percent. However, private nonresidential construction spending advanced 1.6 percent in the latest month. Essentially, housing construction is still depressed by excess supply of unsold homes and the public sector may be seeing a slowing due to budget problems at the state government level. But businesses are optimistic enough to continue to expand in the nonresidential sector.
Construction spending Consensus Forecast for May 08: -0.5 percent
Range: -0.8 to -0.1 percent
Sales of domestic motor vehicles proved very weak in May, coming in at a 10.3 million annual sales rate that is down from 10.5 million in April and the worst results since July 1998. Light trucks sold at a 6.0 million rate for the worst results since 1995 and confirmed the need for GM's recent announcement that it is closing four light truck plants and is putting Hummer on the sales block. Consumers moved to cars which, at an 8.0 million rate, showed the strongest results since May 2007. Cars are significantly less expensive to buy than light trucks and SUVs and also do not empty the wallet as fast at the gasoline station.
Motor vehicle domestic sales Consensus Forecast for June 08: 10.1 million-unit rate
Range: 9.9 to 10.3 million-unit rate
Factory orders rose 1.1 percent in April despite a 0.6 percent decline for durable goods. Overall orders were boosted by a price-related 2.8 percent jump for nondurable goods, primarily for petroleum and coal products. More recently for May, durable goods orders were unchanged, following a revised 1.0 percent drop in April. However, excluding the transportation component, new orders fell back 0.9 percent, following a 1.9 percent surge in April. We can expect higher prices for commodities to once again boost the nondurables component for May orders. But after inflation is taken into account, both durables and nondurables orders now appear to be trending around a flat line.
Factory orders Consensus Forecast for May 08: +0.6 percent
Range: 0.0 to +1.4 percent
Nonfarm payroll employment and unemployment trends have been pointing to a declining labor sector. Nonfarm payroll employment in May fell 49,000 led by declines in construction, professional & business services, retail trade, and manufacturing. On the inflation front, average hourly earnings advanced a moderate 0.3 percent in May. The biggest news was a half percentage point spike in the unemployment rate to 5.5 percent. While the household survey (which produces the unemployment rate) is relatively small – resulting in somewhat volatile monthly numbers – another factor may have been behind the surge. The May spike could have been caused by seasonal adjustment difficulties as May is when some college students enter the labor market. If more students enter the market sooner than seasonal factors assume, that will not be fully taken into account. While we may see a partial reversal in the unemployment rate jump, the weak economy will likely give us a sixth consecutive monthly decline in payroll employment for June.
Nonfarm payrolls Consensus Forecast for June 08: -50,000
Range: -110,000 to 0,000 (unchanged)
Unemployment rate Consensus Forecast for June 08: 5.5 percent
Range: 5.3 to 5.6 percent
Average workweek Consensus Forecast for June 08: 33.7 hours
Range: 33.7 to 33.8 hours
Average hourly earnings Consensus Forecast for June 08: +0.3 percent
Range: +0.2 to +0.3 percent
Initial jobless claims are holding relatively steady at somewhat elevated levels but there has been a steady upward creep in continuing claims. Initial claims were unchanged in the week ending June 21, coming in at 384,000. However, continuing claims reversed the prior week's drop with an 82,000 rise to a four-year high of 3.139 million for the week ending June 14. Initial claims peaked at about 450,000 in the 2001 and 1991 recessions with continuing claims peaking in both recessions at about 3.5 million. The continuing upward trend in continuing claims indicates that the labor market is weaker than suggested by just initial claims and helps corroborate a recent rise in the unemployment rate at least in part.
Jobless Claims Consensus Forecast for 6/28/08: 385,000
Range: 375,000 to 395,000
The composite index from the ISM non-manufacturing survey is showing a flat economy just like its sister manufacturing index. The ISM's composite non-manufacturing index came in at 51.7 for May, falling 3 tenths from April. The business activity index, the former headline index that is now one of four components making up the composite index, showed a little more strength, at 53.6 for a nearly 3 point gain, putting it moderately in positive territory. New orders also nudged up further past the break-even point, rising 3.5 points to 53.6. The big negative as it is in all business surveys is inflation. Prices paid jumped from 72.1 in April to 77.0 in May.
Composite index Consensus Forecast for June 08: 51.0
Range: 48.5 to 52.0
SIFMA recommended early close, 2:00 p.m. ET
U.S. Independence Day. All Markets Closed.
Econoday Senior Writer Mark Pender contributed to this article.
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