Last week saw only one key economic indicator - the consumer price index. The core CPI came in higher than expected but the markets shrugged most of it off. Higher oil prices, however, undermined stocks. Equities were mixed as blue chips retreated while technology and the broader markets posted moderate gains. Rates ended the week down due to flight to quality.
Recap of US Markets
OIL PRICES
Oil prices ended up last week. Prices dipped initially on Tuesday as the March delivery contract expired and on belief that warm weather would be easing demand. Prices jumped Wednesday and Friday. Wednesday's boost was due to refinery and pipeline problems - including a pipeline to the Northeast being shut down due to a spill in Indiana, a fire in a Texas refinery leaving it shut down for several weeks, and BP announcing that it shut down one of its offshore fields off Alaska for unplanned repairs. Friday's gain was due to continued concern over supply problems as well as defiant statements by Iran that it would not be complying with UN demands for it nuclear facilities. Net for the week, spot prices for West Texas Intermediate ended up $1.13 per barrel at $60.52 per barrel, the highest close of the year.
STOCKS
Markets were closed Monday in the U.S. for Presidents' Day. Tuesday was the one day seeing broad gains. The Dow set a record close as a drop in oil prices lifted equities overall. Wal-Mart issued guidance for Q1 on the high end of expectations - also support the Dow. The Nasdaq got a big boost from news that Sirius Satellite Radio and XM Satellite Radio agreed to a merger. Equities did not take the jump in the core CPI as well as the bond market. Wednesday's jump in oil prices also pulled blue chip stocks down. Financials also were weak due to concern over sub-prime lending losses. However, the Nasdaq hit six-year highs on both Wednesday and Thursday. Several semiconductor makers announced better-than-expected Q1 earnings after close on Wednesday. An adverse court ruling pulled down Microsoft as well as the Dow and the Nasdaq. In general, higher oil prices on Thursday and Friday pushed stocks down outside of the oil patch.
Last week, the Dow was down 0.9 percent and the S&P 500 down 0.2 percent. The Nasdaq was up 0.9 percent while the Russell 2000 posted a 1.2 percent gain.
Year-to-date, the Dow is up 1.5 percent; the S&P500, up 2.4 percent; the Nasdaq, up 4.3 percent; and the Russell 2000 is up 5.1 percent.
BONDS
The bond market ended the week little changed but down slightly overall. Markets were closed Monday in the U.S. for Presidents' Day. Key movement was primarily on Thursday and Friday. On Tuesday, bonds moved sideways as traders waited on Wednesday's CPI report and FOMC minutes. On Wednesday, bonds rates initially rose following the higher-than-expected core CPI reading but edged back down after reconsideration that the report was not too worrisome and after the FOMC minutes had no new language to suggest any further bias toward tightening. By the end of the day, rates were up generally one basis point. Rates rose Thursday due to new supply from a 5-year auction and due to renewed concern over inflation. Rates reversed on Friday, falling due to a flight to quality as money moved out of funds holding sub-prime real estate loans.
Net for the week the Treasury yield curve is down marginally except for the 3-month bill. Yields are down as follows: 2-year Treasury note, down 3 basis points; 3-year, down 1 basis point; 5-year, down 2 basis points; the 10-year bond, down 2 basis points; and the 30-year bond, down 1 basis point. The 3-month T-bill is up 1 basis point, remaining tightly linked to a fed funds rate that is not expected to change for some time.
Rates continue a downtrend since late January, reflecting the view of the markets that economic growth is slowing and that underlying inflation is slowly headed down - last week's core CPI notwithstanding. The 3-month Treasury bill has been on a slight uptrend since the end of January. This has been due to an increasing belief that the Fed will not be cutting rates soon.
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 with the highlight being the CPI report at midweek.
Consumer price inflation takes one step back
The improvement seen in recent months in core consumer price inflation partially reversed in January. In January, the consumer price index slowed overall but the core firmed significantly. Overall consumer prices slowed to a 0.2 percent rise in January, following a 0.4 percent jump in December. The moderation was primarily due to weaker oil prices bringing energy inflation down although a jump in food prices and other components kept the number a little higher than expected. The core CPI, however, rose 0.3 percent, following a 0.1 percent increase in December.
A number of components stood out in the January CPI report. First, energy prices moderated the overall CPI as expected. In the non-expenditure category for energy, prices fell 1.5 percent, following a 4.2 percent spike in December. Fuel oil fell 4.4 percent while gasoline prices declined 3.0 percent. Energy costs are down 3.1 percent on a year-on-year basis. Over the last five months, the impact of energy costs on the overall CPI has been quite favorable on average.
Other key movers by expenditure categories included food and beverages, which spiked 0.7 percent in January after a 0.1 percent dip in December. Leading the jump was fresh fruits & vegetables (+1.3%) and dairy (+1.3%). Part of the jump in food prices was due to recent freezes in California growing areas. January's jump in food & beverages prices was the largest since a 0.7 percent boost in April 2005.
CPI strength was seen in some components not seen recently. Medical care surged 0.8 percent in January, "other" jumped 0.8 percent, and apparel rose 0.3 percent.
The January spike in medical care costs is the largest since a 0.8 percent hike in November 1990. The increase in the "other" category was led by a 3.1 percent spike in tobacco prices. The apparel figure stands out because it is a contrast with recent declines. Housing - the usual suspect when the core jumps - actually was moderate with a 0.2 percent gain - including a 0.2 percent rise in owners equivalent rent. Transportation fell 0.8 percent in January, pulled down by a 3.0 percent in motor fuel as well as by a 0.2 percent dip in new & used motor vehicle prices.
Of note regarding the core CPI, the 0.3 percent gain was rounded up from 0.25565 percent. While the core did not head in the right direction, the unrounded number is not as scary. Within the core, tobacco prices surged and likely will not repeat soon. Still the medical component jump is a reminder that we need to worry about more than just owners equivalent rent within the core CPI. However, prescription medications often have published price hikes in January and it is difficult to seasonal adjust.
Despite the jump in the core CPI in January, the recent trend is still lower than six months ago and currently within the Fed's implicit target zone of 1-1/2 to 2 percent. The annualized three-month-ago pace stood at 2.0 in January, compared to 1.6 percent in December.
Year-on-year, the overall CPI stood at 2.1 percent in January, down from up 2.5 percent in December. The core edged up to 2.7 percent from 2.6 percent in December, year-on-year.
The bottom line
Inflation saw a mild reversal with the January CPI report. Several special factors played a role in boosting the core CPI, making the January increase less worrisome. Nonetheless, the latest numbers clearly keep the Fed on hold - further delaying interest rate cuts.
Looking Ahead: Week of February 26 through March 2
Looking ahead, this week includes a number of key indicators such as for housing sales, GDP, and personal income. New and existing home sales will give us an update on whether housing is bottoming out. Usually GDP revisions are boring for the markets but a downward revision could put the economy back under potential and help ease inflation concerns, and the markets will be paying attention to this revision. Personal income is always important since personal income fuels the consumer sector.
Tuesday
Durable goods orders rose 2.9 percent in December, following a 2.2 percent increase in November. However, recent regional manufacturing surveys have been on the soft side along with industrial production. Also, Boeing had a drop in aircraft orders in January and that will pull the headline number down. As usual, the ex-transportation number will help smooth out some of the volatility for the underlying trend. Markets will be watching to see if moderate momentum continues for ex-transportation.
New orders for durable goods Consensus Forecast for January 07: -3.0 percent
Range: -8.3 percent to +1.2 percent
The Conference Board's consumer confidence index has shown improvement recently with a gain in the overall index in January to 110.3 from 110.0 the month before. Lower oil prices, gains in the stock markets, and generally healthy labor markets seem to be sinking in on consumer attitudes. Further gains in confidence will continue to bolster the economy.
Consumer confidence Consensus Forecast for February 07: 108.0
Range: 105.0 to 109.0
Existing home sales slipped 0.8 percent in December to a 6.22 million annual rate, following a 0.5 percent rise in November. Nonetheless, fewer houses came on the market and inventories eased in December to 6.8 months from a very high 7.3 months in November. Last month's report hinted in the text that sales were bottoming. So, markets will be watching to see if sales begin to rise or at least fall at a slower pace and, of course, whether inventories continue to come back in line. Bringing inventories in line and then getting sales up are the first two indicators of a rebound in actual construction of housing which lags somewhat from sales and inventory adjustments.
Existing home sales Consensus Forecast for January 07: 6.25 million-unit rate
Range: 6.0 to 6.4 million-unit rate
Wednesday
In the advance report, fourth quarter real GDP jumped to an annualized 3.5 percent from the 2.0 percent pace in the third quarter. However, in the weeks since the advance report, some of the "missing but assumed" data have come in on the weak side - notably for inventories and some investment components. Markets are expecting a bigger than usual revision to the growth rate and on the down side. If the revision ends up with growth a little lower than 2.5 percent, the markets will likely like the revisions. The Fed is counting on sub-potential growth in the economy to help ease inflation with potential growth estimated at 3.0 percent. Somewhat below potential is good. Above potential is bad because the Fed will either pause longer or even tighten. Substantially below potential is bad because that means weak earnings. We are looking for Goldilocks here - anything in between roughly 2.3 to 2.8 percent for real GDP would be "just right," making the markets happy.
Real GDP Consensus Forecast for preliminary Q4 07: +2.3 percent annual rate
Range: +2.0 to +3.0 percent annual rate
GDP price index Consensus Forecast for preliminary Q4 07: +1.5 percent annual rate
Range: +1.4 to +1.7 percent annual rate
The NAPM-Chicago purchasing managers' index fell to 48.8 in January from 51.6 in December. Weakness was led by a sharp 10 percentage point fall in new orders to 46.3 that points to slowing activity in the months ahead. Backlogs improved marginally but remained in negative territory.
NAPM-Chicago Consensus Forecast for February 07: 50.0
Range: 48.5 to 52.0
New home sales showed improvement last month with a 4.8 percent increase in December to an annual rate of 1.120 million. Supply also fell to 5.9 months from 6.1 months in November. Markets will be watching to see if the trends in both continue - and point to a rebound in actual construction in coming months.
New home sales Consensus Forecast for January 07: 1.08 million-unit rate
Range: 1.00 million to 1.14 million-unit rate
Thursday
Initial jobless claims for the week ending February 17 reversed a big chunk of their prior spike with a 27,000 fall, following a 46,000 surge for the February 10 week. Weather played a big role in both weeks. So the markets will be looking to see how a week with little weather impact (outside of normal seasonal effects) will turn out. Thus far, initial claims in recent weeks have still been consistent on average - emphasizing on average - with modest employment gains.
Jobless Claims Consensus Forecast for 2/20/07: 325,000
Range: 320,000 to 347,000
Personal income was quite healthy in December along with consumer spending. Inflation according to the core PCE deflator was down. Personal income increased 0.5 percent in December - the same as in November. Meanwhile, personal consumption expenditures rose 0.7 percent in December, following a 0.5 percent increase in November. More recently, earnings slowed in the January employment report and retail sales posted healthy gains outside of autos and gasoline. The latest CPI numbers suggest that the core PCE deflator will reverse course somewhat in January. The core CPI rose 0.3 percent in January, following 0.1 percent gains in each of the prior three months. The core PCE deflator has slightly broader coverage than the core CPI but the core CPI is used as input for the vast majority of the core PCE price index.
Personal income Consensus Forecast for January 07: +0.3 percent
Range: +0.1 to +0.4 percent
Personal consumption expenditures Consensus Forecast for January 07: +0.4 percent
Range: +0.2 to +0.5 percent
Core PCE deflator Consensus Forecast for January 07: +0.2 percent
Range: +0.2 to +0.3 percent
Construction spending fell 0.4 percent in December, following a 0.1 percent rise in November. December's fall was led by private residential construction as private nonresidential and public outlays posted healthy gains. Typically, construction outlays lag housing sales notably but with atypically favorable weather helping starts in January, we may see a temporary blip in outlays also.
Construction spending Consensus Forecast for January 07: -0.5 percent
Range: -1.0 to -0.1 percent
The Institute for Supply Management's manufacturing slipped to 49.3 in January from 51.4 in December. The reading is the second sub-50 reading in the last three months, indicating that manufacturing has slowed. While the Fed wants sub-potential growth in the economy, it also does not want a recession. So a return to positive territory would be welcomed.
ISM manufacturing index Consensus Forecast for February 07: 49.7
Range: 48.5 to 50.5
Motor vehicle sales in January came in at a 12.6 million annual rate - the same pace as in December and a little above November's 12.1 million unit pace. The truck share of the market continued to slip as sales of trucks dipped to a 7.3 million rate in January while car sales firmed to 5.3 million. Motor vehicle sales have been important in keeping the consumer sector strong and will continue to play a key role.
Motor vehicle sales Consensus Forecast for February 07: 12.6 million-unit rate
Range: 12.2 to 12.8 million-unit rate
Friday
The University of Michigan's consumer sentiment index slipped back to 93.3 in its mid-month reading, down from 96.9 in January. The expectations and current conditions segments of the index dipped by roughly the same amount. Inflation expectations were unchanged at 3.0 percent. Despite the dip, the 93.3 level is still among the very strongest readings since mid-2004. The labor market, which remains sound, is really the key for confidence.
Consumer sentiment Consensus Forecast for February 07: 93.3
Range: 91.0 to 95.0
Equities mixed in mostly quiet week
