Last week, we had little economic news and the markets moved mainly sideways - at least until Friday when comments by some regional Fed bank presidents nudged rates up and stocks down. The most notable economic report was for productivity and labor costs and those numbers were favorable for continued easing in inflation.
Recap of US Markets
OIL PRICES
Oil prices in recent weeks seem to have settled into a range of $50 to $60 per barrel. Last week, movement was primarily on Wednesday and Thursday. On Wednesday, the spot price for West Texas Intermediate fell $1.17 per barrel from Tuesday's close to $57.71 despite a steeper-than-expected drop in inventories in the weekly data. The price decline appeared to be due to profit taking. But the mild sell-off was short-lived as on Thursday oil prices jumped $2.00 per barrel on the news that U.S. oil producer Occidental said that a fire on Tuesday will keep nearly 120,000 barrels of production offline and with no timeline for a return. Also pushing up oil was a cold spell in the U.S. and saber-rattling by Iranian officials that if the U.S. hits Iranian nuclear facilities, Iran will retaliate by targeting U.S. interests. For the week, spot prices for West Texas Intermediate were up 87 cents per barrel, closing at $59.89 per barrel.
STOCKS
Until Friday, equities for the most part moved sideways with little economic data to move the markets and with few surprises on earnings. One exception was Cisco which on Wednesday reported a 40 percent jump in Q2 earnings which substantially beat expectations. Cisco also boosted guidance for coming quarters which lifted the tech sector - notably the Nasdaq. Small caps did rise on Wednesday and Thursday due to gains largely in the consumer discretionary sector. Weighing the markets down in general were higher oil prices (a cost factor for many). Also of note, lenders were warning of having to write off bad loans in the housing sector - notably those made to home builders with unexpected run-ups in inventories. On Friday, hawkish comments by St. Louis Fed President Poole and Cleveland Fed President Pianalto nudged rates up and equities down. Chip makers pulled down the Nasdaq on Friday and interest rate concerns hit the small caps harder.
Last week, the Dow, was down 0.6 percent; the S&P500, down 0.7 percent; the Nasdaq, down 0.6 percent; and the Russell 2000, down 0.3 percent.
Year-to-date, the Dow is up 1.0 percent; the S&P500, up 1.4 percent; the Nasdaq, up 1.8 percent; and the Russell 2000 is up 2.5 percent.
BONDS
The bond market ended the week with rates little changed to down modestly. Early in the week, rates edged down with slight help from the ISM non-manufacturing report which showed a dip in its price index. Wednesday's good productivity report helped rates ease further, giving a boost to the 10-year quarterly refunding. The 30-year refunding on Thursday also went better than expected, easing rates further. However, on Friday, the hawkish Fed speak led rates to firm. Dallas Fed President Richard Fisher also spoke on Friday but his comments were less hawkish.
Net for the week the Treasury yield curve edged down. Yields are down as follows: 3-month Treasury bill, down 1 basis point; 2-year Treasury note, down 3 basis points; 3-year, down 6 basis points; 5-year, down 5 basis points; the 10-year bond, down 4 basis points; and the 30-year bond, down 7 basis points.
Rates have generally eased since late January, reflecting the view of the markets that economic growth is slowing. The 3-month Treasury bill has been little-changed since early January.
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
Last week had little economic news. However, the productivity numbers were favorable for further easing in inflation.
Productivity helps inflation trend
One of the key areas of continuing concern for the Fed is upward pressure on costs from wages. However, the "shock absorber" between wage inflation and the CPI and other measures of final product or service inflation is productivity. As long as wage inflation is offset by productivity gains, wages are not inflationary overall. Fourth quarter productivity rose sharply with an annualized 3.0 percent boost compared to a 0.1 percent decline in the third quarter. Workers put in more hours, up 1.2 percent, but they produced a 4.2 percent rise in output. Unit labor costs rose a smaller-than-expected 1.7 percent, down from a 3.2 percent rise in the third quarter.
Year-on-year, productivity rose 2.1 percent in the fourth quarter and is up from 1.3 percent in the third quarter. Year-on-year, unit labor costs rose 2.8 percent, down from the 3.1 percent pace in the third and second quarters.
ISM non-manufacturing index strengthens
The Institute For Supply Management's non-manufacturing index jumped in January to 59.0 from 56.7 in December. But sub-indexes were not that strong as new orders showed no new life (55.4 vs. 55.6) and backlogs continued to contract (49.0 vs. 48.0). Employment was also soft at 51.7 vs. 53.2. Nonetheless, the ISM non-manufacturing index has been showing more signs of life recently than the manufacturing index which has basically been holding steady at the flat level.
The ISM non-manufacturing price index remained soft with a reading of 55.2 in January - down slightly from 59.7 the month before. Helping pull down the price index were declines in prices for carbon steel, copper, gasoline, natural gas, polyethylene products, pork products, and PVC Products.
Fed speak and upside inflation risks
While last week's inflation indicators continued to support a recent trend of easing inflation, a number of Fed officials remain skeptical of this progress lasting. Fed officials on the lecture circuit included presidents of the Cleveland, St. Louis, and Dallas Feds and Fed Chairman Ben Bernanke. However, only the regional presidents chose to speak on the status of the economy, inflation, and potential changes in Fed monetary policy.
Quite a few of the comments focused on upside risks to inflation remaining. Cleveland's Pianalto indicated that if the recent improvement in inflation does not continue, then the Fed may still need to raise interest rates. She acknowledged that inflation numbers have improved recently but Pianalto added that she is "not yet convinced that the inflation trend is shifting down." She sees some inflation risks remaining. "As we gain a clearer picture of the underlying inflation trend, we may see that some inflation risks remain. In that case, some additional policy firming may be needed depending, of course, on the outlook for both inflation and economic growth."
St. Louis Fed President Poole indicated that he has concerns about a too strong economy and upside risks on inflation. "But before we declare victory and head home, it's wise to consider some of the upside risks that I worry about. One of these risks, as I've noted earlier, is the possibility that we might be underestimating the likely pace of economic activity. If we get an upside surprise on GDP growth, then monetary policy may have to be tightened somewhat."
Dallas Fed President Richard Fisher was more neutral and not as hawkish on inflation: "I wouldn't rule out further increases in the federal funds rate if inflationary winds gain the upper hand. Indeed, if increases are needed, I would aggressively advocate for them. But for now, I am as comfortable with the inflationary outlook as a prudent central banker can be. No central banker can ever be smug about containing the risk of inflation, but I am pleased with the current direction of inflationary impulses."
Despite some very recent softening in economic indicators, implied fed funds rates in the fed funds futures market have barely budged and indicate the market believes that the Fed will not be cutting interest rates until the end of this year. Odds are just barely greater than 50/50 that the Fed will cut rates at the December FOMC.
The bottom line
The economy is still on a soft landing but Fed officials have been going out of their way to remind markets that establishing a true inflation trend takes some time. It still looks like it is going to be a while before the Fed eases.
Looking Ahead: Week of February 12 through February 16
Looking ahead, this week will make up for last week's paucity of data with a long list of indicators covering international trade, manufacturing, housing, retail sales, and producer prices.
Monday
The U.S. Treasury monthly budget report showed a surplus of $44.5 billion in December, sharply higher than the 10 year average surplus of $11.5 billion that is typical for that month. The month of January typically shows a sizeable surplus for the month. Over the past 10 years, the average surplus for the month of January has been $33.1 billion.
Treasury Statement Consensus Forecast for January 07: $40.0 billion (surplus)
Range: $35.0 billion to $48.0 billion.
Tuesday
The U.S. international trade gap narrowed to $58.2 billion in November from a revised $58.8 billion shortfall in October. In November, overall exports rose 0.9 percent, while overall imports increased 0.3 percent. Gains in exports have helped support manufacturing and any sign of weakness in exports will not bode well for the industrial sector. However, November exports were boosted by a spike in shipments of civilian aircraft and a technical reversal or partial reversal should be expected. It may be hard to get a solid read on the true trend from the December data.
International trade balance Consensus Forecast for December 06: -$59.8 billion
Range: -$62.5 billion to -$57.0 billion
Wednesday
Retail Sales surged 0.9 percent in December, following a 0.6 percent boost in November. Excluding motor vehicles, retail sales spiked 1.0 percent in December, following a 0.7 percent jump in November. Some of December's boost was due to a rebound in gasoline prices. Oil prices have rebounded since mid-January but it is not clear how the increase averaged out for the month and impact gasoline prices. Since the consumer has been the strongest sector and is probably one of the key concerns for the Fed, it will bear close watching how consumer spending is doing - especially after discounting autos and gasoline. A modest ex-autos, ex-service stations sales figure would suit the Fed and the markets.
Retail sales Consensus Forecast for January 07: +0.3 percent
Range: 0.0 percent (flat) to +0.6 percent
Retail sales excluding motor vehicles Consensus Forecast for January 07: +0.3 percent
Range: 0.0 percent (flat) to +0.6 percent
Business inventories rose a moderate 0.4 percent in November, following a gain of 0.2 percent in October. More recently, manufacturers inventories slowed to a 0.1 percent increase in December from a 0.2 percent rise the month before. The latest manufacturing inventory figure will likely help slow the overall inventory number.
Business inventories Consensus Forecast for December 06: 0.0 percent (flat)
Range: -0.2 to +0.3 percent
Thursday
Initial jobless claims rose 3,000 in the week ending February 3 to 311,000. There were no special factors and the level is consistent with moderate job growth.
Jobless Claims Consensus Forecast for 2/10/07: 310,000
Range: 308,000 to 325,000
The Empire State manufacturing index fell to 9.1 in January from 22.2 in December - indicating a slowdown in the New York manufacturing region. New orders remained slightly positive but backlogs stayed slightly in negative territory. The economy may not fall into recession if manufacturing contracts briefly, but it is preferable that manufacturing stay moderately positive as the economy decelerates to bring inflation down.
Empire State Manufacturing Survey Consensus Forecast for February 07: 10.0
Range: 5.0 to 15.0
Import prices jumped 1.1 percent in December due to a spike in import petroleum prices. Since December, prices have been on a weekly roller coaster but on average they appear to be down from December. Excluding petroleum and natural gas, import prices have been mostly subdued. Sustained softness in import prices is needed to help bring down overall inflation.
Import prices Consensus Forecast for January 07: -1.0 percent
Range: -1.9 to -0.4 percent
Industrial production rebounded 0.4 percent in December, following a 0.1 percent decline in November. The largest component, manufacturing, jumped 0.7 percent in December, following no change in November. However, we have recently seen weakness in the Empire State manufacturing survey, the ISM survey, and in production hours in manufacturing. In the January employment situation report released earlier in February, total production hours in manufacturing fell 0.8 percent in January - suggesting a drop in manufacturing output for February.
Industrial production Consensus Forecast for January 07: -0.1 percent
Range: -0.4 to +0.5 percent
Capacity utilization Consensus Forecast for January 07: 81.6 percent
Range: 81.2 to 82.0 percent
The general business conditions component of the Philadelphia Fed's business outlook survey index rebounded moderately in January to 8.3 from a contractionary -2.3 in December.
In general, manufacturing data have been a little on the soft side and that is helpful in bringing inflation down as long as factory output does not turn too negative.
Philadelphia Fed survey Consensus Forecast for February 07: 4.5
Range: 0.0 to 12.0
Friday
Housing starts jumped 4.5 percent in December, following a 6.4 percent rebound in November. December's annualized pace of 1.642 million units was likely boosted by atypically warm and dry weather and a technical dip should not come as a surprise.
Housing starts Consensus Forecast for January 07: 1.60 million-unit rate
Range: 1.50 million to 1.69 million-unit rate
The producer price index jumped 0.9 percent in December, following a 2.0 percent jump in November with upward pressure primarily from oil prices. Most of the rise was in both food and energy. However, the core rate decelerated sharply to a 0.2 percent rise, following a 1.3 percent rebound in November.
PPI Consensus Forecast for January 07: -0.5 percent
Range: -1.0 to -0.1 percent
PPI ex food & energy Consensus Forecast for January 07: +0.2 percent
Range: 0.0 percent (flat) to +0.3 percent
The University of Michigan's consumer sentiment index has shown an improvement in consumer attitudes about the economy with a rise to 96.9 in January from 91.7 in December. Among sub-readings, expectations showed more improvement than current conditions, a sign pointing to rising confidence ahead. One-year inflation expectations edged higher but remain tame at 3.0 percent. Financial markets showed no initial reaction to the report.
Consumer sentiment index Consensus Forecast for preliminary February 07: 96.0
Range: 93.5 to 97.9
Fed speak ends quiet week
