Last week we got our first look at real GDP for the first quarter with the 1.3 percent figure below expectations. This fits the Fed’s plan for the economy to be below potential for a number of quarters to get inflation down. However, the inflation numbers are not cooperating as much as hoped. Meanwhile, manufacturing is staying modestly healthy while housing is still weak. And incidentally – the Dow topped 13,000 for the first time last week. 

Recap of US Markets

OIL PRICES

Oil prices ended last week up sharply.  Spot prices for West Texas intermediate surged $1.96 per barrel on Monday over worries that the Nigerian elections were causing domestic violence there over the legitimacy of the election.  Prices eased on Tuesday as the situation in Nigeria seemed less volatile than feared. On Wednesday, inventories of U.S. motor fuel were at their lowest in 18 months – causing crude oil prices to rebound from Tuesday’s dip. News of a fire at a Marathon oil refinery in Louisiana boosted prices Thursday but progress on monitoring the Iranian nuclear program helped soften the day’s gain. Oil jumped further on Friday on a report from Saudi Arabia of the arrest of 172 militants.

The spot price per barrel for West Texas Intermediate jumped for the week by $3.08 per barrel to close at $66.46 per barrel. This is the highest since early September of last year.

STOCKS

Equities posted broad gains last week. Strength was in the blue chips and tech sector as small caps netted only modest gains. The week, however, started off on the wrong foot as equities generally declined. Higher oil prices, a downturn in Asian markets, and GM announcing that spillover from the subprime lending problem was affecting auto sales caused stocks to turn down on Monday. Stocks were mixed on Tuesday as a very negative report on existing home sales caused worries in some sectors. However, a number of tech companies came out with better-than-expected earnings. Wednesday saw the strongest gains during the week. The Dow, the S&P 500, and the Nadaq all rose just over or just under one percent for the day.  The Dow passed the 13,000 mark for the first time. Boeing and Amazon provided significant lift with strong earnings and higher guidance. Energy stocks were boosted by gains in oil prices. Early Wednesday morning, a robust durable goods orders report put the markets in a positive mood. Markets were a little subdued the rest of the week with the Dow nonetheless ending the week with four consecutive gains. Friday’s weak report on first quarter GDP slowed market momentum and hit the small caps hard as the Russell 2000 fell 0.5 percent. The economy remains moderately healthy but the slower growth now seems to be favoring the large caps.

Last week, the Dow was up 1.2 percent; the S&P 500, up 0.7 percent; the Nasdaq, up 1.1 percent; and the Russell 2000, up, 0.1 percent.

Year-to-date, the Dow is up 5.3 percent; the S&P500, up 5.3 percent; the Nasdaq, up 5.9 percent; and the Russell 2000 is up 5.3 percent.

BONDS

Last week saw rates dip initially on Monday and Tuesday but then edge back up Wednesday and Thursday. Monday was quiet but rates eased as traders prepped for Tuesday’s report on existing home sales. Even though markets expected a decline in home sales, Tuesday’s reported drop was more than expected and pushed rates down. Wednesday was the turning point for bonds as durables orders came in much stronger than expected, new home sales edged up, the Fed’s Beige Book was moderately positive, and oil prices rebounded. Thursday brought a sharp drop in initial jobless claims and a continued rise in oil prices. Rates were steady on Friday as GDP came in below expectations but the report’s price indexes came in above expectations. Over the week, a continued decline in the dollar kept upward pressure on rates.

Net for the week the Treasury yield curve is up only very incrementally except for the 3-month T-bill which edged up. Yields were up as follows: 2-year T-note, up 1 basis point; 3-year, up 2 basis points; 5-year, up 1 basis point; the 10-year bond, up 2 basis points; and the 30-year bond, up 3 basis points. The 3-month T-bill was down 5 basis points.

While little changed last week, markets are recognizing that economic growth is holding up moderately well while inflation is still somewhat stubbornly high – keeping rates higher than during this past November’s lows.

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 economic continues on a modest uptrend with sector strengths mixed.

Real GDP slows while inflation picks up – but inflation rise is old news

First quarter real GDP slowed to an annualized 1.3 percent from the 2.5 percent pace in the fourth quarter. The good news is that the first quarter provided a gap between actual and potential GDP which the Fed is hoping will slow inflation. However, inflation is not fully cooperating. On the inflation front, the GDP price index jumped to 4.0 percent, following a 1.7 percent increase in the fourth quarter. 

The deceleration in growth was due to a decline in exports, a rise in imports, slower government spending, and a marginal slowing in consumer spending. In the other direction, business fixed investment improved while residential and inventory investment were less negative than in the fourth quarter.

On the inflation front, the GDP price index jumped to 4.0 percent, following a 1.7 percent increase in the fourth quarter. The jump in the first quarter was largely related to higher oil prices. The core PCE deflator quickened to a 2.2 percent in the first quarter, after posting a 1.8 percent annualized pace in the fourth quarter. However, the faster pace reflected a change in quarterly averages – the more recent monthly pace is more moderate. The monthly core PCE deflator has been somewhat moderate and the monthly core CPI for March came in at a modest 0.1 percent. We will get a more up-to-date reading on the core PCE deflator on Monday of this week and given the modest CPI gain, it also will likely post a modest gain.

Separate from the impact of components on deceleration (the change in growth), overall strength remains in personal consumption, which posted a 3.8 percent annualized increase, following a 4.2 percent boost in the fourth quarter. Equipment investment and nonresidential structures rose 1.9 percent and 2.2 percent, respectively. The equipment component reflected a modest rebound from a decline the prior quarter.

The consumer sector continues to provide the bulk of support for economic growth with solid gains in personal consumption over the last two quarters.

Net exports widened to a $597.8 billion shortfall from a $582.6 billion gap in the fourth quarter. This reflected an annualized 1.2 percent drop in exports, following a 10.6 percent surge in the prior quarter. Imports rebounded 2.3 percent after a 2.6 percent drop in the previous quarter. The export drop likely reflects coming off of a very strong third quarter. Similarly, imports came off a very weak third quarter which posted a modest decline.

Residential investment remains a drag on the economy.  While not quite as negative in the first quarter, residential investment fell an annualized 17.0 percent in the fourth quarter, following a 19.8 percent drop the prior quarter.  Residential investment’s decline knocked 1.0 percentage point off of overall GDP growth.

Inventory growth slowed sharply in the first quarter to a $14.8 billion gain from a $22.4 billion rise in the third quarter. The inventory deceleration seems to be reasonably well managed – indicating that notable overhang has not developed and will not be weighing on the economy in coming quarters.

Year-on-year, real GDP fell to up 2.1 percent in the first quarter from 3.1 percent in the fourth quarter. Year-on-year, the GDP price index edged up to up 2.7 percent from up 2.5 percent in the prior quarter. The core PCE deflator growth rate was unchanged at up 2.2 percent in the fourth quarter.

Looking forward, the consumer sector seems to be holding up quite well and inventories are being brought into line without too much drag on manufacturing. However, export growth may be stalling but with the dollar so weak, we may see moderate export growth resuming.

Employment costs moderate but the wage component firms

The employment cost index rose a softer-than-expected 0.8 percent in the first quarter, following a 0.9 percent increase in the fourth quarter. The deceleration was due primarily to a sharp slowing in benefits growth – to a quarterly 0.1 percent from 1.1 percent in the final quarter of 2006. The benefit reading, subdued by lower employer contributions to retirement plans, is the lowest in eight years.

In contrast, the wage & salary component accelerated to 1.1 percent for the steepest gain in six years and following a 0.7 percent boost in the fourth quarter. Fed officials have been concerned about tight labor markets and this latest report will only heighten those concerns.

Housing sales are mixed

In March, existing home sales dropped sharply while new home sales nudged up. Existing home sales fell a sharp 8.3 percent in March to an annual rate of 6.12 million. This was the largest monthly drop since January 1989 and the lowest sales level since June 2003. The data also included a sharp rise in supply and sales declines across all four regions. Sales are believed to have been hurt by bad weather and tightened lending standards resulting from subprime lending problems. The existing home market is hurt more by tightened lending standards than the new home market since new homes tend to have higher income purchasers than the existing home market, as indicated by differences in median sales prices.

Supply rose to 7.3 months from 6.8 months in February and 6.6 months in January. The median price rose 1.6 percent in the month to $217,000, though the year-on-year price is down 0.3 percent.

New home sales edged up a modest 2.6 percent to 858,000 but included a sharp drop in supply that will help to limit pressure on builders and prices. But annual unit rates for both February and January were revised lower by a net 21,000 units.

Supply fell back to 7.8 months from an extremely swollen 8.1 months in February. The median sales price for new homes came in at $254,000 and was up 6.4 percent year-on-year and 0.9 percent on the month.

Durables orders show resilience

With a number of regional manufacturing surveys showing a soft manufacturing sector, concern has risen that manufacturing is slowing too much. With housing still down, a declining manufacturing sector could spell trouble for the economy. However, the March durable goods report was quite positive – the second consecutive healthy report. Durable goods orders increased 3.4 percent in March, following a 2.4 percent partial rebound in February. Excluding the volatile transportation component, new orders rose 1.5 percent, following a 0.4 percent decline in February.

Strength in orders in March was broad based.  Industry categories posting gains in March were primary metals, fabricated metal products, machinery, communications equipment, electrical equipment, transportation, and “other,” up 0.4 percent. The only major industry category showing weakness was computers & electronics.

Overall, today’s report shows modest strength in manufacturing.  Equities should be boosted by this good news while bond prices are likely to dip.

The bottom line

The economy is still quite sound although strength obviously varies by sector with the consumer strong, housing weak, and manufacturing in between. The economy still is strong enough to provide moderate growth in earnings overall. In fact, there is increased discussion that the “product” side of GDP is underestimating growth and that the income side is stronger and suggests we may see upward revisions to GDP growth. We get to see new income numbers this week.

Looking Ahead: Week of April 30 through May 4

Looking ahead, the week is bracketed with two key reports — personal income on Monday and the employment situation on Friday. We get additional reports on manufacturing and productivity in between.

Monday

Personal income growth was strong in February with a robust 0.6 percent increase. The wage component also was healthy with a 0.4 percent gain. However, on the inflation front, the overall PCE deflator jumped to 0.4 percent in February, following a 0.2 percent increase the month before. The core PCE price index (excluding food and energy) firmed to 0.3 percent, following a 0.2 percent increase in January. Income growth should remain moderately healthy in March given the strong gain in payroll jobs which is only partially offset by a slower gain in average hourly earnings. The overall PCE deflator should rise sharply again in March, reflecting higher oil prices. The soft March CPI figure of 0.1 percent, however, suggests a modest gain in the core PCE deflator.

Personal income Consensus Forecast for March 07: +0.6 percent
Range: +0.3 to +0.9 percent

Personal consumption expenditures Consensus Forecast for March 07: +0.5 percent
Range: +0.3 to +0.7 percent

Core PCE deflator Consensus Forecast for March 07: +0.1 percent
Range: +0.1 to +0.2 percent

Construction spending rebounded in February with a 0.3 percent increase, following a 0.5 percent drop in January. As in recent months, the gain was led by nonresidential and public construction outlays. Starts have shown some recent strength due to atypically warm weather and this may boost the residential component of construction outlays temporarily.

Construction spending Consensus Forecast for March 07: +0.1 percent
Range: -0.5 to +0.5 percent

The NAPM-Chicago purchasing managers’ index surged in March to 61.7 from 47.9 in February. However, this survey sometimes has a small sample size and is notoriously volatile.

NAPM-Chicago Consensus Forecast for April 07: 54.0
Range: 50.4 to 57.0

Tuesday

The Institute for Supply Management’s manufacturing index was flat in March, coming in at 50.9 vs. February's modestly higher 52.3. New orders also slipped back to just above break even.

ISM manufacturing index Consensus Forecast for April 07: 51.0
Range: 49.5 to 52.5

Motor vehicle sales softened somewhat in March, coming in at a 12.2 million annual rate. However, strength was mainly with foreign transplants as domestic makers continued to see declining sales.

Motor vehicle sales Consensus Forecast for April 07: 12.3 million-unit rate
Range: 12.1 to 12.5 million-unit rate

Wednesday

Factory orders rebounded 1.0 percent in February, following a 5.7 percent drop in January. Strength was in durables. More recently, in the advance report for durables, orders posted a sharp 3.4 percent increase with widespread gains by components that should keep overall orders strong in March.

Factory orders Consensus Forecast for March 07: +2.0 percent
Range: +1.5 to +2.6 percent

Thursday

Initial jobless claims fell sharply in the week ending April 21, dropping 20,000 to 321,000 in a positive sign for the labor market. While there were no special factors in the latest week, the drop does put initial claims near to where they were before the recent spike.

Jobless Claims Consensus Forecast for 4/28/07: 320,000
Range: 315,000 to 335,000

Nonfarm productivity in the fourth quarter rebounded a modest 1.6 percent annualized after declining 0.5 percent in the third quarter. Little improvement is likely in the first quarter given the very modest 1.3 percent rise in first quarter GDP. Many of the output components in productivity come from the same sources as for real GDP. Also, employment has been fairly healthy in the first quarter – pointing to a notable rise in the hours portion of productivity. Nonetheless, the market’s focus is likely to be on unit labor costs. Unit labor costs increased an annualized 6.6 percent in the fourth quarter – sharply higher than the 1.1 percent rise in the third quarter.

Nonfarm Productivity Consensus Forecast for initial/revised Q1 07: +0.5 percent
Range: 0.0 (flat) to +2.0 percent rate

Unit Labor Costs Consensus Forecast for initial/revised Q1 07: +3.9 percent rate
Range: 0.0 (flat) to +5.0 percent rate

The business activity index from the ISM non-manufacturing survey fell sharply for a second month, to 52.4 in March from 54.3 in February indicating slowing growth. New orders also slipped toward the break even mark. Prices paid jumped to 63.3 from February's 53.8 – primarily due to higher energy costs rather than due to shortages.

Business activity index Consensus Forecast for April 07: 53.5
Range: 50.9 to 55.0

Friday

Nonfarm payroll employment was quite strong in March, up 180,000 following a revised 113,000 gain in February. While manufacturing employment declined by 16,000, construction jobs rose by a sharp 56,000. The construction jump was likely due to atypically warm weather in March and we may see a reversal of that pulling down construction jobs and slowing overall employment growth. But look to other sectors to see if recent strength continues – and discount any moderate weakness in construction. On the inflation front, average hourly earnings rose 0.3 percent in March, following a 0.4 percent increase in February. The March figure was neither inspiring for inflation progress nor alarming. But the markets and the Fed will be watching to see if wage pressures are improving or not – especially after last week’s employment cost report with strong wage gains in the first quarter.

Nonfarm payrolls Consensus Forecast for April 07: +100,000
Range: +40,000 to +135,000

Unemployment rate Consensus Forecast for April 07: 4.5 percent
Range: 4.3 to 4.6 percent

Average workweek Consensus Forecast for April 07: 33.8 hours
Range: 33.8 to 33.9 hours

Average hourly earnings Consensus Forecast for April 07: +0.3 percent
Range: +0.3 to +0.4 percent