BONDS
Treasury yields were generally lower this week, perhaps partly due to the fact that the quarterly refunding was over and partly because inflation news was relatively sanguine. And while economic growth is still positive, it doesn't appear to be accelerating. By Friday, though, yields backed up a bit, and the week's drop in yields was reduced by a few basis points. Nonetheless, yields are down across the maturity spectrum from last week. Note that the yield spread between 10-year and 2-year notes continues to narrow.

Markets at a Glance

The Economy
INFLATION IS THE PROBLEM...OR MAYBE NOT'
The producer price index increased 0.7 percent in October, less than September's 1.9 percent hike, but surely, a large gain nonetheless as energy prices jumped 4.1 percent. The producer price index now stands 5.9 percent above year ago levels. In contrast, the PPI excluding food and energy prices fell 0.3 percent, helped by a 3 percent drop in auto prices and a 2.2 percent drop in light truck prices. Most 2006 model year cars were introduced in October. Home electronic equipment and apparel prices were also down for the month.

The consumer price index increased 0.2 percent in October, a much better showing than the 1.2 percent gain posted in September. Energy prices inched down 0.2 percent after surging 12 percent in September. Food prices increased 0.3 percent for the second straight month. Excluding food and energy prices, the CPI increased 0.2 percent, twice as much as the average monthly gain of 0.1 percent posted in the six months. Even though apparel prices and education & communication prices dipped during the month, housing costs surged, boosted by swelling hotel & lodging costs. In contrast to the PPI, new car prices increased 0.5 percent in the CPI (where they had fallen in the PPI).

On the whole, it does not appear that inflationary pressures are developing outside the energy sector. This doesn't mean that inflation won't accelerate in the next few months, but the October report was not particularly scary.

RETAIL SALES DOWN - AND UP
Retail sales dipped 0.1 percent in October due to a 3.6 percent drop at motor vehicle and parts dealers. This was the third straight monthly drop in the auto group. Excluding autos, retail sales increased 0.9 percent in October, smaller than the two previous months' gains. Of course, high and rising gas prices helped boost dollar sales at gasoline stations. The opposite was true in October - gas station sales dipped 0.8 percent during the month. To avoid dealing with gas price issues, we like to look at retail sales excluding autos and gas station sales: these rose 1.1 percent in October, the largest monthly gain since April.

Sales were pretty healthy across the board, with the exception of miscellaneous store retailers (includes such categories as florists and pet store supplies). Building materials stores, clothing & accessory stores, department stores and nonstore (catalog, electronic, etc) retailers all performed well in October. With the drop in gasoline prices, consumers may have had some extra money to spend on other goods and services during the month.

Since this is the beginning of the holiday season, retail analysts as well as economists are anxious to see how the consumer sector will fare this year. Some anecdotal evidence suggests that Internet sales are rising sharply over a year ago. Perhaps consumers would rather shop online that spend money on gas to drive to the mall.

HOUSING STARTS
Housing starts declined 5.6 percent in October to a 2.014 million-unit rate after rising to a 2.134 million-unit rate in September. Many analysts categorized the housing drop as a "sinking" of starts. But in fact, housing starts are volatile from month to month and according to the Census Bureau's stated statistical confidence interval of plus or minus 7.7 percent; the actual posted decline was not statistically different than zero. Of course, economists have been calling for a drop in housing construction for more than a few months - and it isn't surprising that housing activity might drop given the 30 basis point hike in average mortgage rates in October. Housing starts peaked early in 2005 and have been moderating since then.

Many analysts also made a big deal about the sharp drop in housing permits - suggesting that these also point to further declines in housing starts. Actually, 95 percent of the time, housing permits and housing starts will move in tandem in any given month. Housing starts are indeed likely to decline further in coming months, but increases in mortgage rates would have told you that - not a one-month drop in permits.

INDUSTRIAL PRODUCTION
The index of industrial production grew 0.9 percent in October, recovering a little more than half of the 1.5 percent drop posted in September. The bulk of the September drop can be attributed to the Boeing strike and damage caused by hurricanes Katrina and Rita. It is somewhat disappointing to see that the entire decline was not reversed, but this reflects the less than stellar performance in the industrial sector of the economy.

Manufacturing production jumped 1.4 percent after declining 0.7 percent in the previous month. Taking a two-month average leaves us with just about the average monthly gain of the past several months in manufacturing. Mining fell 0.5 percent in October, after a whopping 8.6 percent plunge in September. Utilities production decreased 2.5 percent in October after posting smaller declines in the three previous months.

Among key sectors that we monitor, selected high tech industries gained 1.7 percent in October and are now 24.8 percent higher than a year ago. In contrast, motor vehicles & parts production fell 0.6 percent and is only 4.7 percent higher than last October. Production of consumer goods excluding high tech, vehicles and energy was flat in October after increasing 0.6 percent in September. Production of business equipment (excluding those same three categories) jumped 8.2 percent in October after declining 6.3 percent in September. Construction (excluding the three categories) was up 1.3 percent in October after posting solid gains in the three previous months as well.

Will industrial activity improve in November' It is difficult to tell at this point. The general conditions index from the Philadelphia Fed's business outlook survey fell back in November from the October level. In contrast, the Empire State manufacturing survey accelerated in November from the October level. In any case, both are showing that manufacturing is still expanding in those Federal Reserve districts in November.

The Bottom Line
The inflation news was generally in line with expectations in that the reports were less severe in October than in September. Energy prices were still up in the PPI and fell just slightly in the CPI. Given that gasoline prices continue to fall, we could see some better news in November. Of course, we need to consider home heating costs as well. Core inflation does not appear to be accelerating, but is at the top end of the range with which Federal Reserve officials are comfortable.

Retail sales - outside the auto sector - were pretty good suggesting that consumers were shopping again now that gasoline prices have moderated a bit. Whether this means it will be a good holiday season, though, is too soon to tell.

The industrial sector of the economy did rebound somewhat in October, but the sector is still on the sluggish side.

Looking Ahead: Week of November 21 to November 25

Monday
Several components of the index of leading indicators were positive in October: new jobless claims improved, the factory workweek increased, as did vendor performance and the yield spread. Some components posted declines: building permits, stock prices, consumer expectations.

Leading indicators Consensus Forecast for Oct 05: 0.9 percent
Range: 0.2 to 1.1 percent

Wednesday
New jobless claims declined 25,000 in the week ended November 12 to 303,000 - a seven-month low. Fewer and fewer claims are related to hurricanes Katrina and Rita each week, although a few more in the week were related to Wilma.

Jobless Claims Consensus Forecast for 11/19/05: 315,000 (12,000)
Range: 300,000 to 320,000

At the mid-November reading, the University of Michigan's consumer sentiment index increased more than five points, rising to 79.9. No doubt, consumers are feeling more optimistic now that gasoline prices have declined from their highs.

Consumer sentiment Consensus Forecast for Nov 05: 80.9
Range: 79.9 to 84