By R. Mark Rogers, Senior Economist, Econoday

April 20, 2007

Last week gave us mostly positive news on the economy. The markets especially liked the favorable retail sales and core CPI numbers. Helping boost equities were some key and positive earnings reports. Meanwhile, oil prices remain a concern on the inflation front despite a weekly net decline.

Recap of US Markets

OIL PRICES

Oil prices swung notably during the week but ended down slightly. The first notable movement was Tuesday as an announcement that a key Nigerian oil field would restart sooner than expected pushed prices down. On Thursday, a report on sharply higher distillate inventories in the U.S. resulted in another drop in prices. However, on Friday concern over the weekend presidential election in Nigeria not being definitive and interrupting shipments led prices back up sharply. The spot price per barrel for West Texas Intermediate declined net for the week $0.25 per barrel to close at $63.38 per barrel. Crude oil prices remain significantly higher than during recent lows this past November.

STOCKS

Equities posted healthy gains last week, with the blue chips leading the way. Starting the week off, strong retail sales on Monday boosted stocks. Also supporting equity gains were positive comments on Citigroup which lifted financials, and Google’s announcement to buy DoubleClick pushed up techs. Tuesday was mixed even as a rise in housing starts and an easing in the core CPI were favorable. Blue chips were led in part by Coca-Cola and Johnson & Johnson with earnings beating expectations. Homebuilder stocks generally rose. Techs slipped partly due to the view that earlier strong gains were over done. On Tuesday, the blue chips again led the way as the Dow closed at a record high over 12,800. On Wednesday, JP Morgan Chase came in with strong earnings to help the large caps as did Boeing with news on an uncontested bid for a South Korean airliner deal. IBM and Yahoo! disappointed and pulled techs down. Thursday was a downer for major indexes except for the Dow which barely closed up. A soft index of leading indicators and flat Philly Fed index played a part in equity weakness. Markets also were focusing on a report of very strong economic growth in China with Chinese authorities indicating that they would take measures to slow growth. Asian and European markets had big selloffs prior to the open U.S. markets. However, equities roared back on Friday with strong earnings out of Google, Caterpillar, and Honeywell. The Dow closed above 12,900 for the first time. Net for the week, all major indexes posted healthy gains but with the blue chips outpacing techs and especially the small caps.

Last week, the Dow was up 2.8 percent; the S&P 500, up 2.2 percent; the Nasdaq, up 1.4 percent; and the Russell 2000, up, 1.2 percent.

Year-to-date, the Dow is up 4.0 percent; the S&P500, up 4.7 percent; the Nasdaq, up 4.6 percent; and the Russell 2000 is up 5.2 percent.

BONDS

Last week saw rates ease despite some unexpectedly healthy economic news. On Monday, rates eased on lower oil prices even though retail sales were robust. A flat Empire State manufacturing report also helped. Also, some of the movement was in anticipation of the Tuesday CPI report. On Tuesday, markets ignored the oil-induced spike in the overall CPI and focused on the better-than-expected 0.1 percent rise in the core CPI. The moderation in the core CPI outweighed a strong manufacturing industrial production figure and unexpected rise in housing starts. A dip in oil prices during Tuesday also helped bump rates down. The soft core CPI continued to help ease rates on Wednesday. Rates were little changed on Thursday and Friday except for the 10-year and 30-year Treasuries which nudged up slightly.

Net for the week the Treasury yield curve is down. Yields were down as follows: 3-month T-bill, down 3 basis points; 2-year T-note, down 11 basis points; 3-year, down 13 basis points; 5-year, down 12 basis points; the 10-year bond, down 9 basis points; and the 30-year bond, down 8 basis points.

Recent improvement in the core PPI and core CPI have helped rates come down slightly from recent highs earlier in April.

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

The three key factors boosting equities last week were a strong retail sales report, an easing in core CPI inflation, and generally better-than-expected earnings reports by companies.

Retail sales show consumers still doing their part

Retail sales in March were quite healthy even after discounting autos and gasoline sales. Retail sales increased 0.7 percent in March, following a 0.5 percent rise in February.  Excluding motor vehicles, retail sales rose 0.8 percent in March, following a 0.4 percent increase in February. The consensus had forecast a 0.9 percent jump in retail sales excluding motor vehicles. Excluding both gas station and motor vehicles components, retail sales increased 0.4 percent in March, following a 0.3 percent rise the prior month. Other components were generally positive. 

Retail sales were generally positive in March and broad-based. Component declines were few.

While an early Easter likely helped to boost clothing and higher gasoline prices added to service station sales, the numbers are broadly positive and clearly indicate a resilient consumer sector.

Year-on-year, overall retail sales in March rose to up 3.8 percent from up 3.5 percent in February. Excluding motor vehicles, February’s year-on-year sales advanced to up 3.9 percent, compared to up 3.5 percent in February. Excluding motor vehicles and gas station sales, year-on-year sales in March were up 3.8 percent – unchanged from February.

Looking past just the March numbers, where is strength in consumer spending' On a quarterly basis (January through March over September through December), the biggest retail sales gains have been in service station sales, clothing, furniture, and general merchandise. Certainly, a rebound in gasoline prices pushed up services station sales but gains in the other components look good. Clothing is up quite strong – although a little of that may be due to an early Easter. Furniture has been surprisingly strong. Because furniture is a discretionary household durable good (purchases can be deferred during bad economic times), the rise in furniture sales is a good sign that consumers see their financial situation as generally sound – regardless of how they answer surveys. Electronics sales were weak in the first quarter but that is partly due to coming off of strong sales in the fourth quarter.

Consumer prices come in mixed but markets focus on improved core

Consumer prices were divergent in March with the overall rate rising while the core rate slowed. The consumer price index in March jumped to a 0.6 percent increase, following a 0.4 percent rise in February. The core CPI eased to a 0.1 percent increase in March, following a 0.2 percent rise in February. The core rate slowed mostly on a drop in apparel prices and a slowing in medical care inflation.

The spike in the overall CPI was primarily due to a jump in energy prices. Energy prices pushed up the overall CPI as expected while food price inflation moderated.  Energy prices surged 5.9 percent in March, following a 0.9 percent increase in February. The jump was led by a 10.6 percent increase in gasoline prices.

The markets focused mainly on the slowing in the core CPI. We have had two months in which the core CPI has been below 0.3 percent but Fed officials continue to point out that the core CPI is still somewhat volatile and takes time to establish the true trend. Based on either a year-on-year rate or a 3-month-ago-annualized rate, core inflation is still above a 2 percent pace – above the Fed’s implicit target zone of 1 to 2 percent inflation.

Year-on-year, the overall CPI stood at up 2.8 percent in March, rising from up 2.4 percent in February.  The core rate edged down to up 2.5 percent on a year-on-year basis, compared to up 2.7 percent the month before.

Industrial production shows surprising strength in manufacturing

Industrial production weakened in March but weakness primarily was in utilities as manufacturing posted a sizeable increase. Overall industrial production fell 0.2 percent in March, following a 0.8 percent boost in February. By sectors, manufacturing output jumped 0.7 percent, following a 0.1 percent increase in February. For March, utilities output dropped 7.0 percent while mining output edged up 0.1 percent. Given that overall weakness was primarily in utilities and that manufacturing surged, the report should be seen as quite healthy. Even for utilities, the weakness was a technical reversal of the February spike caused by unseasonable cold in parts of the U.S.

Most of the strength in manufacturing in March was led by durables but nondurables output also was quite healthy. Durables output jumped 0.9 percent in March, following a 0.1 percent rise in February. Nondurables advanced 0.5 percent, following no change the prior month.

Overall capacity utilization in March slipped to 81.4 percent from 81.6 percent in February. For manufacturing, capacity utilization stood at 80.1 percent in March, up from 79.7 percent in February.

Empire State and Philly Feds surveys point to soft manufacturing

Both the New York and Philly Fed manufacturing surveys came in flat last week. The Empire State index edged up to a mere 3.8 in April from 1.9 in March – zero is the break even point for no growth. New orders also were just barely above zero. The Philly Fed index stood at 0.2 in April – unchanged from the prior month. New orders also were essentially flat.

Price indexes were mixed as both the New York Fed and Philly Fed surveys both showed a softening in prices received but a firming in prices paid.

However, much of the rise in prices paid was due to higher oil prices.

The bottom line

The markets have at least for now discarded notions of pending recession and recognized that both economic data and earnings reports have been moderately healthy on a net basis. Few expect the Fed to ease soon but the softening in the core CPI in March gives the markets hope that inflation is indeed slowly easing and that the Fed will ease perhaps starting near the end of this year.

Looking Ahead: Week of April 23 through April 27

Looking ahead, we get two reports on the status of housing sales, more information on manufacturing with the durables report, and the initial reading on first quarter GDP. The Fed’s Beige Book comes out Wednesday afternoon.

Tuesday

Existing home sales gave the equities markets a boost last month with sales posting a sharp 3.9 percent. But supply on the market failed to improve, at 6.7 months vs. 6.6 months in both January and December. Focus again will be on both the sales pace and the supply of unsold homes.

Existing home sales Consensus Forecast for March 07: 6.40 million-unit rate
Range: 6.30 to 6.76 million-unit rate

The Conference Board's consumer confidence index unexpectedly fell back sharply in March while inflation expectations picked back up. The Conference Board's index fell to 107.2 in March from February's 111.2. Since the March reading, the stock market has improved and may boost confidence but gasoline prices also have been rising and could push confidence in the other direction. Subprime lending issues remain but have not had as much media play and that could be less of a negative for confidence.

Consumer confidence Consensus Forecast for April 07: 105.0
Range: 103.0 to 107.5

Wednesday

Durable goods orders posted a 1.7 percent gain in February. But excluding transportation (which includes the volatile orders for aircraft), durables orders slipped 1.0 percent in February. Markets are expecting a boost in overall durables in March due primarily to a sharp increase in aircraft orders already made public by Boeing.

New orders for durable goods Consensus Forecast for March 07: +2.2 percent
Range: +0.8 percent to +6.4 percent

New home sales have not shown the same resilience as existing home sales. New home sales fell 3.9 percent in February to an annual rate of 848,000 units - the lowest rate in nearly seven years. Also, supply jumped to 8.1 months - up from 7.3 months in January and 6.1 months in December and the highest level in 16 years. Weather effects were mixed in February with the Northeast and Midwest experiencing worse-than-usual winter while the West was warmer. Sales need to pick up before starts can do the same.

New home sales Consensus Forecast for March 07: 0.890 million-unit rate
Range: 0.850 million to 0.970 million-unit rate

The Beige Book prepared just prior to the March 20-21 FOMC meeting indicated that the economy was slowing but that labor markets remained tight. The markets will be watching to see how the latest Beige Book might affect Fed thinking for the May 9 FOMC statement. Few expect any change in the fed funds rate but the Fed could change the bias in the statement and that will be the Fed’s next step prior to cutting rates.

Thursday

Initial jobless claims have yet to reverse Easter's upward distortion and may be pointing to a softer labor market. Initial claims fell 4,000 in the week ending April 14 to a 339,000 level. A sharper drop was expected since the prior week saw a jump of 19,000 the prior week and many attributed the increase to the shortened workweek before Easter. The lack of much reversal suggests a weaker labor market instead.

Jobless Claims Consensus Forecast for 4/21/07: 329,000
Range: 325,000 to 330,000

Friday

GDP for the fourth quarter came in at an annualized 2.5 percent and followed a 2.0 percent annualized increase in the third quarter. Markets are expecting a sluggish first quarter. Barring a figure that is not too far from the consensus, focus will be on the composition of GDP (final sales, inventories, investment, personal consumption among others) for hints at future growth. Also, markets will be focusing on the inflation numbers – especially the core PCE price index, the Fed’s favorite inflation indicator. The fourth quarter GDP price index posted an annualized increase of 1.7 percent, the same as for the third quarter. The core PCE deflator came in at an annualized 1.9 percent in the fourth quarter.

Real GDP Consensus Forecast for advance Q1 07: +1.8 percent annual rate

Range: +1.4 to +2.7 percent annual rate

GDP price index Consensus Forecast for advance Q1 07: +3.1 percent annual rate
Range: +2.4 to +3.8 percent annual rate

The employment cost index for civilian workers eased to a quarterly 0.8 percent in the fourth quarter from a 1.0 percent rise in the third quarter. Still, the fourth quarter rate is high enough to indicate wage pressure – a key concern for the Fed.

Employment cost index Consensus Forecast for Q1 07: +1.0 percent simple quarterly rate
Range: +0.8 to +2.2 percent simple quarterly rate