The FOMC announced after their meeting on Tuesday, to no one's surprise, that they increased the federal funds rate target by 25 basis points to 3 percent. The Fed left in its comment that its policy remains accommodative and left intact wording that the removal of accommodation will be at a "measured" pace. Financial market players were debating whether the word "measured" would be removed or not at this meeting.
The most interesting thing about the statement was what the Fed inadvertently, and only briefly, left out - "Longer-term inflation expectations remain well contained." They corrected the statement nearly 2 hours later to make sure the sentence was included. Conspiracy buffs made all sorts of suggestions about the comment. The Fed would lose credibility in a heartbeat if they actually acted mischievously or frivolously. Chances are the statement was indeed inadvertently dropped and that the FOMC wanted to correct it as soon as possible.
According to some analysts, the post-meeting statement was considered less hawkish with the addition of the statement that longer term inflation expectations remain well contained. It is true that the statement implies that the Fed is primarily worried about short-term inflation, rather than long-term inflation at this time due to the inherent volatility of energy prices.
Most economists agree that the Fed's neutral zone on the federal funds rate target is somewhere between 3 and 5 percent in the current environment. The Fed certainly has room to move higher in the next few months, but as we approach a neutral fed funds rate target, the pace of Fed rate hikes, which has been completely predictable so far, might become more of a question mark. (Note that the emphasis on the inserted longer-term inflation sentence below is the Fed's.)
"The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices. Labor market conditions, however, apparently continue to improve gradually. Pressures on inflation have picked up in recent months and pricing power is more evident. Longer-term inflation expectations remain well contained.
The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."
Recap of US Markets
STOCKS
Equity investors go back and forth on worries that the Fed will continue to remove policy accommodation by faster rate hikes. The April employment report showed unexpected good news on the labor market, but as equity investors came to realize that this would give the Fed more support to raise rates, the initial rally faded. Back and forth, investors can't decide if they want to see stronger growth or low interest rates. Actually, stronger growth is likely to promote healthier corporate profits even if rates head higher. GM and Ford also dominated the news this week as their debt was downgraded to junk bond status. Shares fell on this news. On Friday, investors had the additional worry that bank profits would be dampened by the potentially higher interest rate environment.
BONDS
Fed actions are usually important for bond investors. But this week's Fed rate hike was no surprise and after a little flurry of activity due to the corrected post-meeting statement, it was to square one. But bond markets were hit by Friday's unexpectedly robust employment report that caused investors to fear an acceleration of Fed rate hikes.
Furthermore, the Treasury securities' market had additional excitement this week with the Treasury's announcement on Wednesday that they are considering re-issuing the 30-year bond twice a year. The Treasury announced in October 2001 that 30-year bonds would no longer be issued. With a few years of annual budget surpluses in the late 1990s and early 2000s, that made some sense.
Budget surpluses are now just dreams. Budget deficits have skyrocketed under the policies of the Bush administration. The Treasury Borrowing Committee of the Bond Market Association has recommended several times in the past few years that the Treasury re-issue 30-year bonds. But by re-issuing this long term security, the Treasury is admitting that budget deficits have indeed returned with a vengeance. But there is no question that given today's low interest rate environment, the 30-year bond will help keep Treasury borrowing costs low in the future.
According to the Treasury, they will not make a final decision on whether or not they will issue 30-year bonds twice a year amounting to $20 - $30 billion with a start date of February 2006. Does that sound like a trial balloon' Chances are good that the Treasury will decide positively in August.
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
Nonfarm payrolls jump - and so does the employment-population ratio
Nonfarm payroll employment jumped 274,000 in April after upward revised gains in February and March which cumulatively added 93,000 to payrolls over the period. Factory payrolls dipped again, but construction employment increased sharply among goods-producing industries. Service-producing industries posted a healthy 229,000 hike in April, almost twice as strong as the previous month's hike. Gains were widespread across the various industries and not concentrated in any single sector. This is usually a good sign about the status of the economy.
The civilian unemployment rate remained unchanged at 5.2 percent in April. Household employment jumped in April, for the second straight month, and the labor force grew sharply in April as well. This is masked by an unchanged jobless rate. That's why we like to look at the employment to population ratio, which increased to 62.6 in April, its highest level since October 2002. There is certainly room for growth in the employment-to-population ratio, but this latest upward trend is encouraging.
Using the employment situation to predict personal income and industrial production
Factory payrolls along with the manufacturing workweek go a long way in predicting the current month's industrial production figures. Factory payrolls dipped, but the manufacturing workweek increased by six minutes in April. These figures point to an industrial production gain of roughly 0.2 - 0.3 percent for the month.
Personal income growth should be stronger than the past several months given that private payrolls increased 0.2 percent, the average workweek rose 0.6 percent and hourly earnings rose 0.3 percent in April. This combination of gains could easily lead to a 0.6 to 0.9 percent rise in wages & salaries, the lion's share of personal income. In March, personal income grew 0.5 percent when wages and salaries increased 0.3 percent. Thus, the April figures should be pretty healthy!
Productivity growth moderates in Q1
Nonfarm productivity grew at a 2.6 percent rate in the first quarter of 2005 after increasing at a slower 2.1 percent rate in the fourth quarter of last year. Quarterly patterns tend to be more volatile than year-over-year gains. On a year-over-year basis, nonfarm productivity increased 2.5 percent in the first quarter, a slower pace than the previous quarters. Notice how rapidly productivity grew between 2001 and 2003, during the recession and in the first two years of economic recovery. This was a very difficult period for employment growth. However, now that employment gains are accelerating, productivity has moderated. This is a typical pattern over the business cycle. More rapid GDP growth in the early recovery phase would have spurred employment growth. But given that the employment gains were modest to nil before, we are finally seeing a better labor environment today.
Factory orders drop off in Q1
Total new manufacturers' orders inched up 0.1 percent in March despite a 2.3 percent drop in durable goods orders. New orders for nondurable goods jumped 2.8 percent, and this helped to offset the weakness. Nonetheless, nondefense capital goods orders were down 5.6 percent for the month. The quarterly picture is somewhat less bleak since new orders were still stronger in the first quarter of 2005 relative to the fourth quarter of 2004. However, the pace was fairly anemic. With sluggish new orders, the chances for healthy production growth down the pike (within the next 3 - 6 months) doesn't bode too well. Of course, the backlog of orders is always high, but without an improving trend in new orders, this won't hold true for very long.
ISM manufacturing survey shows downward trend
The ISM manufacturing index fell back to 53.3 in April from a level of 55.2 in March. The index is down 9 percentage points from a year ago, showing the moderation in the manufacturing sector. Any level above 50 percent still reflects an expanding sector, but the slower pace is discouraging.
Among the various components of the ISM manufacturing survey, new orders decreased more than three points, employment and supplier deliveries fell one point, although they each remained above the 50 percent mark.
ISM non-manufacturing survey moderates in April
The business activity index from the ISM non-manufacturing survey dipped to 61.7 in April from a level of 63.1 in March. Overall, the non-manufacturing survey tends to show more strength in the economy than the manufacturing survey. While the business activity index is not at its highest level we have seen in the past 12 months, it remains relatively robust.
The non-manufacturing survey does not yet have a composite diffusion index, and so market analysts monitor the business activity index which is actually akin to the production index in the manufacturing version of the survey. Other components of the survey show declines in the index for new orders and employment, but supplier deliveries were unchanged and inventories rose from the previous month. In all cases, the indexes were well above the 50 percent mark which signifies economic expansion.
The Bottom Line
The FOMC met and decided to raise the federal funds rate target by 25 basis points to 3 percent, to no one's surprise. They did manage to create a little excitement by inadvertently forgetting a sentence in their post-meeting statement and correcting their statement a couple of hours later. It led market player to ponder conspiracy theories and perhaps revise their views of the hawkish flavor (or not) of the post-meeting statement. After all was said and done, it was another ho-hum event from the Fed.
April's employment situation showed a pretty darn good picture of the labor market. As regular readers of this column know, we like to monitor the employment-population ratio in addition to the regular payroll figures and the jobless rate. This ratio did improve, although it remains at relatively low levels. But the trend is good and there were no real special factors in the employment report that would make one discount the April spurt. The employment figures on the whole suggest that personal income growth will be healthy in April. This could help boost retail sales - or at least offset some of the negative factors stemming from still-too-high gasoline prices.
Several key indicators will be reported next week. As the international trade deficit becomes ever larger, it gets more attention in the financial markets. We already know that motor vehicle sales rose in April, but market players will be interested in non-auto retail sales on Thursday and preliminary figures on consumer sentiment on Friday.
Looking Ahead: Week of May 9 to May 13
Wednesday
The international trade deficit on goods and services widened yet again in February to post a $61 billion shortfall. Exports were roughly unchanged last month, although imports rose 1.6 percent. Given the high energy bill, it wouldn't be surprising to see a similar deficit for March.
International trade balance Consensus Forecast for Mar 05: $-61.5 billion
Range: $-63.8 to $-60 billion
The U.S. Treasury is scheduled to release its monthly budget report for April. Since tax payments are made this month, the U.S. Treasury usually reports a surplus. Over the past 10 years, the average surplus amounted to $93.9 billion. However, the surplus was only $17.6 billion last year.
Treasury budget Consensus Forecast for Apr 04: $58 billion
Range: $55 to $70 billion
Thursday
New jobless claims rose 11,000 in the week ended April 30 to 333,000, posting the second weekly rise in a row. After falling sharply in mid-April, claims are on the rise again.
Jobless Claims Consensus Forecast for 5/7/05: 330,000 (-3,000)
Range: 300,000 to 340,000
Retail sales rose 0.3 percent in March; excluding autos, sales also rose 0.1 percent. April motor vehicle sales increased nearly 4 percent and this will surely boost retail sales for the month. High gasoline prices are probably hampering discretionary expenditures though.
Retail sales Consensus Forecast for Apr 05: 0.8 percent
Range: 0.4 to 1.2 percent
Retail sales ex autos Consensus Forecast for Apr 05: 0.6 percent
Range: 0.1 to 0.9 percent
Friday
Import prices jumped 1.8 percent in March. This was mostly due to a spurt in petroleum prices as non-oil import prices inched up only 0.3 percent in March. April's energy price hike is not expected to be as large.
Import prices Consensus Forecast for Apr 05: 0.5 percent
Range: 0.1 to 0.8 percent
Business inventories increased 0.5 percent in February. In March, manufacturers' inventories rose 0.6 percent. Wholesale trade and retail trade inventories grew slower in February than in January.
Business inventories Consensus Forecast for Mar 05: 0.6 percent
Range: 0.4 to 0.9 percent
The University of Michigan's consumer sentiment index fell to 87.7 in April from higher levels in the four previous months. Undoubtedly, rising gasoline prices are dampening consumer optimism.
Consumer sentiment Consensus Forecast for mid-May 05: 87.5
Range: 86.5 to 97.7
Employment growth & Fed rate hikes
