BONDS
The U.S. Treasury yield curve reflects lower rates on Friday the 13th relative to last week's close after the surging employment report. The bond market withstood some healthy economic figures this week as well, such as retail sales and a narrower international trade deficit. But the stronger economic data didn't seem to matter much on the whole. It seems that Friday the 13th, in particular, has a history of bond market rallies according to market pundits. And today was no exception. Furthermore, bond investors shifted funds to the Treasury in a flight to quality move caused by rumors of trouble in the swap market.

The conundrum continues - the Fed hikes its target rate, but market rates don't seem to follow the upward climb.

Markets at a Glance

Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.

The Economy

April retail sales jump
Retail sales jumped 1.4 percent in April, posting the largest monthly gain since last September thanks to a 2.5 percent spurt in motor vehicle sales. But that's not all. Excluding the auto group, retail sales increased 1.1 percent for the month, the strongest monthly showing since last October. Many analysts blamed the Census Bureau's seasonal adjustment process for Easter, which held down sales in March and boosted sales in April. It is indeed more difficult to adjust for seasonal variations when holidays are movable, such as Easter as opposed to Christmas which is always on the same date!

In such cases, it is more appropriate to look at the average growth in March and April rather than the two months separately. Consequently, there is no question that sales at furniture & home furnishing stores are showing a marked slowdown, having posted no growth over the last two months after averaging monthly gains of 0.6 percent from December to February. Similarly, electronics & appliance store sales declined an average 0.3 percent in March and April after gaining an average 1.2 percent per month from December to February.

Low mortgage rates continue to help the housing market. Building materials and garden equipment stores increased an average 1.6 percent per month in March and April after increasing only 0.7 percent per month in the three previous months.

Clothing & accessory store sales as well as general merchandise store sales didn't fare as well as stores selling durable goods in March and April, posting gains of 0.3 and 0.4 percent per month, respectively.

To no one's surprise, gas station sales averaged monthly gains of 2 percent in March and April, faster than the monthly average gain of 0.5 percent in the three previous months. This reflects higher prices, not increased demand for gasoline!

All in all, the retail sales figures were pretty healthy, although not perhaps as strong as indicated by the headline numbers given the problems with seasonal adjustment. Nonetheless, the average rise of 0.9 percent per month over the two months for total retail sales is better than the average (0.7 percent) for the three previous months, and the average 0.7 percent gain for nonauto retail sales was about in line with the average for the three previous months. This means that consumer spending is on par with the past several months. It doesn't appear that higher gasoline prices are exerting strong downward pressure on total retail sales - or at least not as much as many analysts feared.

It is also worth noting that while consumer confidence has been falling in the past several months, retail sales have continued to post relatively healthy gains. The University of Michigan's consumer sentiment index dipped again in mid-May to 85.3 from a level of 87.7 in April. Consumers are more concerned about the economic situation six months hence than they are worried about the current situation.

International trade deficit narrows!
The international trade deficit on goods and services narrowed dramatically in March to $55 billion after jumping to $60.6 billion in February. Exports managed to post a healthy 1.5 percent hike for the month, while imports dropped 2.5 percent. On a year-over-year basis, both are continuing to decline from faster growth in mid-2004. Among exports, the strongest showing was an increase for nonauto capital goods. Not surprisingly, crude oil posted the largest gain on the import side. The auto and consumer goods groups posted sharp declines.

According to a recent Bloomberg article, the Port of Los Angeles is still overflowing with ships bringing imports - and we haven't even reached the busy season which should be starting in the next month or two. Most likely, this suggests that March's narrower deficit is just a fluke - and we should expect more import growth in coming months.

April Federal budget surplus is the largest in three years
The U.S. Treasury announced a budget surplus of $57.7 billion in April, not quite offsetting March's $71.3 billion deficit. Nevertheless, the April surplus is larger than that posted for April in fiscal years 2003 and 2004. Lest we get overly excited about this fact, it is useful to remember that the April surplus is still a long way off from the 10-year average surplus of nearly $94 billion for this month.

For the first seven months of fiscal year 2005, the deficit amounts to $236.9 billion, roughly $47 billion less than the deficit for the same period last year. Receipts are up 13.7 percent in FY05 relative to the same period last year with a healthy 16.1 percent rise in individual income tax receipts and a whopping 47.8 percent hike in corporation tax receipts. Keep in mind, though, that individuals account for the lion's share of receipts. However, the gain in corporate income taxes suggests that profits have indeed improved over the past year relative to last year.

While it appears that this year's budget deficit will probably be smaller than FY04's deficit of $412.6 billion, there is no question that the red ink continues to flow. The U.S. Treasury said they are studying whether they will start re-issuing the 30-year bond, but they won't give us a definite answer until August. However, they have already determined that the 30-year bond will be auctioned semi-annually and the first 2006 auction would take place in February, hypothetically that is. It appears that the Treasury is indeed getting ready to issue the long bond - and it is likely to be well received by the bond market. In fact, most bond investors were sorry to see it go in 2001 - when it appeared that the U.S. would be experiencing surpluses, rather than deficits, for several years. The U.S. may have had a reversal of fortune, but at least this will bring back the long bond, which has been sorely missed.

Import prices moderate, but still high
The import price index increased a mere 0.8 percent in April after surging 2 percent in March. Petroleum import prices moderated - rising only 3.1 percent after spurting 12.3 percent in March and 5 percent in February. Prices of non-petroleum imports inched up 0.4 percent, faster than the average gains of the three previous months.

Notice that the energy price index from the producer price index correlates well, on a year-over-year basis, with the petroleum import price index. This suggests that the PPI may see a rise in the energy portion as well for the month of April.

The Bottom Line
Economic news was generally good this week with strong retail sales and a narrower trade deficit. Even though consumers are less optimistic about economic conditions than they were six months ago, it doesn't seem to be affecting their spending at all.

This week the strong economic news helped to lift the foreign exchange value of the dollar versus the euro and the yen, yet it did nothing to lift bond yields. Indeed, interest rates fell despite the continuing upward trend in the federal funds rate target.

The equity market was rather bearish this week since good news lifted prices much less than bad news depressed prices. And it didn't even seem to matter that crude oil price futures fell below $50 for two straight days this week.

Market players will have lots of economic news to mull over in the first part of the week with the Empire State Manufacturing Survey on Monday, inflation news on Tuesday and Wednesday, as well as housing starts and industrial production on Tuesay.

Looking Ahead: Week of May 16 to May 20

Monday
The Empire State manufacturing index fell back to 3.1 in April from a level of 20.2 in March. The April level is at the lowest level since April 2003 when the index declined to -19.7.

Empire State index Consensus Forecast for May 05: 11
Range: 3 to 16.7

Tuesday
Housing starts plunged 17.6 percent in March to a 1.837 million-unit rate. This was the lowest rate since last November when it also stood close to 1.8 million. Mortgage rates are relatively stable despite Fed rate hikes lately, and this could still help the housing market.

Housing starts Consensus Forecast for Apr 05: 1.97 million-unit rate
Range: 1.9 to 2.2 million-unit rate

The producer price index increased 0.7 percent in March with large gains in energy prices. Excluding food and energy, the PPI increased a more modest 0.1 percent for the month. Energy prices rose again in April, and these could boost the total PPI figure, although economists are looking for slower growth in the core PPI.

PPI Consensus Forecast for Apr 05: 0.4 percent
Range: 0.1 to 0.7 percent

PPI ex food & energy Consensus Forecast for Apr 05: 0.2 percent
Range: 0.1 to 0.4 percent

The index of industrial production rose 0.3 percent in March. April might be a little stronger since the average workweek increased 0.3 percent, although factory payrolls were roughly unchanged. The market consensus is looking for a slightly weaker number.

Industrial production Consensus Forecast for Apr 05: 0.2 percent
Range: -0.2 to 0.7 percent

Capacity utilization rate Consensus Forecast for Apr 05: 79.5 percent
Range: 79.2 to 79.8 percent

Wednesday
The consumer price index increased 0.6 percent in March with a modest increase in food prices but a sharp 4 percent increase in energy prices. The core CPI rose 0.4 percent for the month. Gasoline prices continued to rise in April and this should boost the total CPI, although economists are not looking for any acceleration in the core components.

CPI Consensus Forecast for Apr 05: 0.4 percent
Range: 0.3 to 0.6 percent

CPI ex food & energy Consensus Forecast for Apr 05: 0.2 percent
Range: 0.1 to 0.3 percent

Thursday
New jobless claims rose 4,000 in the week ended May 7 to 340,000, posting the third weekly rise in a row. After falling sharply in mid-April, claims are on the rise again.

Jobless Claims Consensus Forecast for 5/14/05: 330,000 (-10,000)
Range: 320,000 to 340,000

The index of leading indicators has negative and positive factors in April. For instance, new jobless claims fell, but that is a positive for this index. The factory workweek rose, also a positive contribution. Vendor performance fell during the month, as did stock prices, consumer expectations and the spread between the 10-year note and the fed funds rate.

Leading indicators Consensus Forecast for Apr 05: -0.2 percent
Range: -0.4 to +0.2 percent

In contrast to the Empire State Survey, the Philadelphia Fed's business outlook survey jumped in April to 25.3. Even with a slight moderation, this index will likely remain well above the zero mark and point to continued growth in manufacturing activity in this Fed region.