Jobs and ISM reports boost rates, equities
By R. Mark Rogers, Senior Economist, Econoday
July 6, 2007
Last week gave us the two ISM surveys along with the June employment situation. All came in moderately healthy to strong, keeping upward pressure on interest rates. Equity markets saw the economy as continuing moderate growth and supporting stock gains despite the higher rates. Equities, however, seem oblivious to last week’s huge surge in oil prices. Trading last week was a little thin due to the Independence Day holiday on Wednesday which allowed many to take extended weekends on both sides of the 4th.
Crude spot oil prices jumped sharply last week, reaching highs not seen since last summer. Gains were steady all week but spiked notably on Friday. On Monday, crude spot prices for West Texas Intermediate closed above $71 per barrel on expectations that U.S. refinery operations would be rising after extended maintenance in the first half of the year and would draw down crude stocks in the U.S. and worldwide. Also, the International Energy Agency on Monday stated that it expected a surge in demand in coming weeks. Throughout the week, the energy patch gained from the gain in oil prices. The oil inventory report came out on Thursday due to the Wednesday holiday. Crude stocks rose notably and in contrast to expectations for a mild drop. Gasoline supplies also rose as refiners were operating at a much higher capacity. Prices dipped initially after the report, but by the end of the day, crude prices were up modestly in thin trading and on concern over an expected pick up in demand. Friday saw the biggest spike in oil prices with a gain of $1.00 per barrel for the day. The run up was due to violence by militants in Nigeria disrupting supply and due to OPEC recalcitrance in expanding output. Worldwide supplies are shrinking while demand is picking up.
The spot price per barrel for West Texas Intermediate was up last the week by $2.13 per barrel to close at $72.81 per barrel. Crude has not closed over $72 per barrel since mid-August of last year.
The continued rise in oil prices must be a concern for the Fed. While outside the definition of “core” inflation, oil prices eventually have an impact on the core through increased costs of production and through changes in inflation expectations. Only about six months ago, the Fed had been stating that it was counting on lower oil prices to help bring core inflation down – along with other factors. We will likely see the opposite concern in the upcoming release of FOMC minutes if not in the following one.
Equities appeared to defy gravity last week with moderately strong gains in major indexes despite notable gains in interest rates and a spike in oil prices. Investors focused on the positives in two ISM reports and in the June employment report. The biggest gain was on Monday with support coming from a very healthy ISM manufacturing report, a dip in interest rates (albeit temporary), and generally favorable corporate news. One standout was Amazon which reported that pre-orders for the seventh and final installment of the Harry Potter series set an all-time high in the U.S. and worldwide. The Nasdaq set a new 6-1/2 year high. Merger news provided most of the boost to stocks on Tuesday’s pre-holiday shortened trading day with euphoria from Monday’s surprisingly strong ISM report carrying over. Merger news boosted Google and Wendy’s while Apple was lifted by a report that iPhone sales will boost profits more than previously believed. However, weak auto sales numbers pulled down General Motors. Thursday was mixed with techs leading the gainers and with the Dow edging down. The Nasdaq set another 6-1/2 year high, lifted by Apple and Google, among others. Broader markets were weighed down by interest rate concerns as a strong ISM non-manufacturing report boosted rates. Equities finished the week with moderately healthy gains across all major indexes. For the most part, investors decided that they liked the overall feel of the June employment report – that it was close to “just right.”
Last week, all major indexes were up: the Dow, up 1.5 percent; the S&P 500, up 1.8 percent; and the Nasdaq, up 2.4 percent; and the Russell 2000, up 2.2 percent.
Year-to-date, the Dow is up 9.2 percent; the S&P 500, up 7.9 percent; the Nasdaq, up 10.4 percent; and the Russell 2000 is up 8.2 percent.
The yield curve was up notably last week. However, the week started off in the other direction on Monday. Rates edged down with flight to quality over concern over further fallout from subprime lending problems. Rates headed north on Tuesday on thin trading and largely on a reversal of Monday’s flight to quality. Spot prices for crude oil topping $71 per barrel also helped rates firm. On Thursday, rates were boosted sharply by a strong ISM non-manufacturing report. Friday’s moderately strong employment report provided the final push on rates for the week. Also, the bond market seems to be paying more attention to higher oil prices than are equities. Many in the bond market see the Fed as being averse to monetizing oil price increases with rate cuts to stimulate the economy as was the case in the 1970s.
Net for the week the Treasury yield curve was up. Yields were up as follows: 3-month T-bill, up 14 basis points; 2-year T-note, up 12 basis points; 3-year, up 12 basis points; 5-year, up 16 basis points; the 10-year bond, up 15 basis points; and the 30-year bond, up 14 basis points.
Interest rates rebounded last week, remaining near cyclical highs.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
Last week’s economic data showed the manufacturing sector improving and labor markets moderately strong. However, there were signs of some pull back by the consumer. During the week, concerns rose about the strength of the economy and it was clear by the end of the week that the economy was strong enough and oil prices high enough, that there is little reason for the Fed to ease any time soon.
The employment situation for June came in moderately strong. While equities ended up seeing the report as almost Goldilocks (close to “just right”), the Fed is less likely to see the report that way. First, nonfarm payroll employment rose by 132,000, following gains of 190,000 in May and 122,000 in April. The June gain alone can be considered very moderate. However, May's payroll increase was revised up 33,000 from the initial estimate of 157,000 new jobs and April was revised up 42,000 from the previous estimate of an 80,000 increase - the net revision was up 75,000. The upward revisions probably leave the Fed seeing payroll growth overall a little too much on the high side for bringing inflation down.
On a year-on-year basis, nonfarm payroll employment rose 1.5 percent in June – unchanged from May.
Within the payroll survey, gains primarily were in service-providing industries – goods-producing industries were mixed. Manufacturing fell another 18,000, following a 7,000 drop in May. Natural resources & mining jobs increased by 3,000 in June while construction rebounded 12,000 in June after slipping 2,000 in May. A key piece of good news from the employment report is this gain in construction employment even as housing continues to slide. Nonresidential and public construction sectors are supporting construction job gains. Overall service-providing industries increased 135,000 in June, following a robust 199,000 boost in May.
The wage numbers were not bad but they also showed no notable improvement from trend. On the inflation front, average hourly earnings increased 0.3 percent in June, following a 0.4 percent boost in May. A 0.3 percent boost in wages is still providing some support for labor costs on the upside.
While there is not 100 percent correlation between wage inflation and CPI inflation, the still high wage trend is a concern for the Fed – especially in combination with high oil prices. Year-on-year, current average hourly earnings growth is still not much below the cycle high – 3.9 percent in June, compared to 4.3 percent in December of last year. The trend is headed down but very incrementally and not fast enough for the Fed to be ready to cut interest rates.
Turning to the household survey, the civilian unemployment rate was unchanged at 4.5 percent in June. The Fed’s concern here is that there still is not much slack in the labor market. June’s unemployment rate is only 0.1 percentage point above the cycle low of 4.4 percent.
There are further signs that manufacturing is strengthening. Purchasers reported a third straight month of very strong growth in June as the Institute For Supply Management's manufacturing index rose 1 point to 56.0. New orders are especially strong, at 60.3 for a gain of 7 tenths and pointing to rising production and perhaps employment in the months ahead. Backlog orders are beginning to pile up, at 53.5 for a 1 point gain and further pointing to stronger activity ahead. The ISM report comes on the heels of a robust Chicago-NAPM report, which also includes non-manufacturers, and other regional surveys that are strictly manufacturing – such as the Empire State and Philly Fed surveys – which are showing notable improvement.
There was mixed news on the inflation front. Prices paid slipped 3 points to 68.0 in June but remains high. Much of this is still energy related. Other input prices are not showing such pressure as manufacturers’ suppliers are making deliveries faster – indicating increased slack in the supply chain. The vendor performance index has been on a modest decline since the end of last year. Despite the spike in prices paid, there are no notable supply shortages.
The ISM non-manufacturing index – following a strong ISM manufacturing report - added to the view that the economy is strengthening. The ISM non-manufacturing index rose to 60.7 in from 59.7 in May. The price index in the non-manufacturing survey was not as brisk as in the ISM manufacturing survey, coming in at 65.5 in June – down from 66.4 in May. Businesses in the non-manufacturing survey are not as dependent on oil as an input as are many manufacturers.
Factory orders fell 0.5 percent in May offering a new reminder that data on the manufacturing is mixed. But this really is old news. Weakness was in durables, reflecting a one-month drop in new orders for Boeing aircraft for the most part. Numerous manufacturing surveys have since come in stronger, Boeing has had a pick up in new orders, and Friday’s employment report showed a boost in manufacturing production hours.
The Fed may be getting a little more slowing in the consumer sector and the markets may be missing this possible fact. Unit new motor vehicle sales were soft in June, keeping in line with what appears to have been a soft month for other retailers. Combined sales of U.S.-made autos and light trucks came in at an 11.6 million unit annualized pace, following a 12.2 million unit pace in May. Sales of light trucks, at a 6.5 million annual rate, failed to pick up in the month despite a roughly 20 cent dip in gasoline prices to just under $3 per gallon. Car sales were likewise soft at a 5.1 million rate. Sales at GM were especially soft with Ford and Chrysler doing little better. Japanese brands did very well with sales of German sports cars mixed. The bottom line is that the consumer expenditures portion for second quarter GDP is being revised down. We may see overall GDP growth more in the vicinity of 2-1/2 percent instead a 3 percent plus figure many were discussing a few weeks ago. Such a number would make the Fed happy – at least a little bit.
From the Fed’s perspective, the economy is still relatively strong with healthy employment growth and new signs for improvement in manufacturing. Still, the numbers cannot be considered “scary” or supporting a boost in inflation – other than the issue of sharply higher oil prices. The consumer sector is showing signs of moderation – more so than many have noticed. But again, the degree of change is modest. Overall, the economy is in a balancing act of a tight but not tightening labor market, a more cautious consumer sector, improving manufacturing, a construction sector with declining housing but rising nonresidential and public construction, and easing core inflation but higher oil costs. The Fed likely sees the mechanisms in place to bring inflation down with no further tightening but still with long lags. The Fed stays on hold while the economy remains moderate.
Next week is highlighted by the international trade report for May and the retail sales report for June. The retail sales report will be particularly important since it will help flesh out forecasts for the consumer expenditure spending portion of second quarter GDP.
Consumer credit rose a lower-than-expected $2.6 billion in April, reflecting the month's weak retail sales and only moderate vehicle sales. Revolving credit fell $0.4 billion as consumers, despite high gas prices, managed to scale back credit car use. Non-revolving rose $3 billion, well down from $7.3 billion in March.
Consumer credit Consensus Forecast for May 07: +$5.6 billion
Range: +$4.2 billion to +$9.4 billion
The U.S. international trade gap narrowed sharply in April to $58.5 billion from $62.4 billion in March. Imports fell 1.9 percent while exports edged up 0.2 percent. The import improvement was primarily outside of petroleum. Import weakness was led by declines in imports of consumer goods and autos. Imports of non-auto capital goods also declined. Markets should focus on whether the decline in non-oil imports continues. Further weakness in these imports could indicate whether businesses are expecting a softening in demand in the U.S. However, with the recent uptrend in crude oil prices, one should expect a jump in petroleum imports and a likely rise in overall imports. In turn, we may see a sharp rise in the overall trade gap.
International trade balance Consensus Forecast for May 07: -$60.0 billion
Range: -$61.5 billion to -$58.3 billion
Initial jobless claims Initial jobless claims were little changed in the June 30 week, up 2,000 to a 318,000 level and still consistent with tight conditions in the labor market. The four-week average rose slightly to 318,500.
Jobless Claims Consensus Forecast for 7/7/07: 315,000
Range: 310,000 to 320,000
The U.S. Treasury monthly budget report showed the Treasury's deficit coming in at $67.7 billion in May. The results narrowed the fiscal year-to-date improvement to 35 percent: $148.5 billion vs. $227.0 billion in May of last year. Looking ahead to this week’s release, the month of June typically shows a moderate surplus for the month. Over the past 10 years, the average surplus for the month of June has been $36.0 billion.
Treasury Statement Consensus Forecast for June 07: $30.0 billion surplus
Range: $20.0 billion surplus to $49.0 billion surplus
Retail sales rebounded a sharp 1.4 percent in May, following a 0.1 percent dip in April. May gains were led by gasoline sales but increases were widespread and robust. Excluding gas, retail sales advanced 1.2 percent in May, while excluding just motor vehicles, sales increased 1.3 percent. Excluding both motor vehicles and gas stations, sales rebounded 1.0 percent, following a 0.2 percent drop the month before. Retail sales are a little volatile and it should not be surprising to see a pull back in June in some categories. Unit sales of U.S.-made vehicles, released last week, declined to 11.6 million annualized in June from 12.2 million in May, suggesting that the motor vehicles component in retail sales will likely decline for the month. However, the service station component will be under upward pressure from higher oil prices – although gasoline prices have been lagging the increases in crude oil prices.
Retail sales Consensus Forecast for June 07: 0.0 (flat) percent
Range: -0.6 to +0.6 percent
Retail sales excluding motor vehicles Consensus Forecast for June 07: +0.2 percent
Range: -0.2 to +0.7 percent
Import prices jumped 0.9 percent in May and were still up 0.5 percent when excluding the month's 2.7 percent jump in import prices of petroleum. But year-on-year rates in May showed less pressure, up 1.1 percent for total import prices and up 2.8 percent excluding petroleum. But more recently, crude oil prices have been rising and the dollar has continued to weaken. Both of these factors are likely to push up import prices in June.
Import prices Consensus Forecast for June 07: +0.6 percent
Range: +0.4 to +1.0 percent
Business inventories rose 0.4 percent in April and trailed a 0.7 percent rise in business sales that shaved 1 tenth off the stock-to-sales ratio to 1.27. The low inventory ratio is good for preventing the buildup of unwanted inventories and supports further gains in manufacturing and in imports. More recently, manufacturers’ inventories were up a moderate 0.3 percent in May – down from up 0.4 percent in April.
Business inventories Consensus Forecast for May 07: +0.3 percent
Range: +0.3 to +0.4 percent
The University of Michigan’s Consumer sentiment index slipped to 85.3 in June from 88.3 in May. The index has come down notably from a recent peak in January at 96.9. While the recent numbers are not indicative of any dramatic weakening in the consumer sector, neither are they pointing to a robust consumer.
Consumer sentiment Consensus Forecast for preliminary July 07: 86.0
Range: 85.0 to 88.0
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