Economy and markets mostly steady at quarter end
By R. Mark Rogers, Senior Economist, Econoday
September 28, 2007
This past week brought an end to an unusually turbulent third quarter with the economy moderately healthy outside of housing. Equity and bond markets have stabilized and even rebounded for the most part. But problems still lurk ahead in a depressed housing sector that could have further negative effects spilling over into the consumer sector and slowing economic growth. In the meantime, the Fed is keeping its finger on the pulse of both inflation and real growth, weighing the data on whether to ease further or not. And Fed Speak last week had some surprises for those who think they have the Fed’s course all laid out.
Equities were mixed this past week with techs posting the largest gains and small caps declining. Stocks generally declined on Monday due to profit taking after the prior week’s Fed induced gains, concern over the GM strike, and due to warnings from homebuilders. At mid-week, tech stocks led the markets as many saw that sector as relatively immune to subprime lending problems. Equities ended the week and the quarter on the downside despite generally positive economic news on personal income, construction outlays, and Chicago business activity. The spur to profit-taking on Friday was St. Louis Fed President William Poole’s comments that the Fed essentially has not made up its mind on further interest rate cuts and that it might not be wise for markets to build in such cuts. Hardest hit were the small caps which tend to react the most to changes in interest rates.
Last week, most major indexes were up. Major indexes were up as follows: the Dow, up 0.5 percent; the S&P 500, up 0.1 percent; and the Nasdaq, up 1.1 percent. However, the Russell 2000 was down 0.9 percent.
September was a good month for equities in general, thanks to the Fed’s 50 basis point cut in the fed funds target rate and in the discount rate. The S&P 500 and the Nasdaq both were up 4.0 percent while the S&P 500 posted a 3.6 percent boost for the month. The small caps were sluggish with only a 1.6 percent gain for the month, with the last trading day of the month trimming the increase. The Russell 2000 fell 1.1 percent on the last trading day of September.
Despite the sharp declines in equities in early August over the subprime-related credit crunch, most stocks ended the third quarter with moderate gains with techs and the Dow leading the way. The Nasdaq rose 3.8 percent in the third quarter with the Dow close behind with a 3.6 percent gain. The S&P 500 increased a modest 1.6 percent but the Russell 2000 fell 3.4 percent.
Year-to-date, the Dow is up 10.9 percent; the S&P 500, up 7.6 percent; the Nasdaq, up 10.6 percent; and the Russell 2000, up 2.3 percent.
Rates generally edged down last week with the near end being an exception. Rates came off inflation worries a little which had been boosted the prior week by the Fed’s 50 basis point interest rate cut at the September 18 FOMC meeting. Helping interest rates nudge down were very weak existing and new home sales as well as good news on the core PCE price index. Continued strong oil prices, generally over $80 per barrel, did keep upward pressure rates. The 3-month T-bill had been headed down during the week along with other rates until St. Louis Fed President William Poole warned markets not to assume that further Fed rate cuts were guaranteed as imminent, pushing the 3-month T-bill up for the week.
Treasury yields were down as follows in the week: 2-year T-note, down 9 basis points; 3-year, down 12 basis points; the 5-year, down 7 basis points; the 10-year bond, down 5 basis points; and the 30-year bond, down 7 basis points. The 3-month T-bill rate rose by 8 basis points.
The 3-month T-bill remains soft on expectations of additional upcoming Fed rate cuts while the long bond rates, despite some modest softening last week, remain lifted by inflation concerns.
Oil prices remain in the stratosphere with spot prices for West Texas Intermediate above $80 per barrel most of last week. Prices dipped below $80 per barrel on Wednesday on news of an unexpected rise in overall oil stocks. But prices firmed again Thursday on concern over a drop in stocks at Cushing, Oklahoma, a key delivery point in the U.S. market. Worries over Iran’s nuclear program and violence around Nigerian oil fields also kept prices over the $80 mark.
The spot price for West Texas Intermediate slipped $1.76 per barrel for the week to close at $81.66 per barrel and remain $1.76 per barrel below the record close set on Friday, September 21.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
Last week showed a housing sector that continues to worsen but the rest of the economy is moderately healthy. Even though inflation has eased into the Fed’s implicit target range, Fed officials warned that there is no guarantee that further interest rate cuts by the Fed are imminent.
Some economic commentators are continuing to make odds of recession in the coming year but those odds are very low as long as the consumer sector continues on an uptrend. And the biggest factor behind consumer spending is income growth. Despite the modest decline in employment in August, personal income rose 0.3 percent in for the month, following a 0.5 percent boost the prior month. Wages gains did slow to a rise 0.2 percent, after rising 0.4 percent in July. If employment rebounds in September as most expect, then income should firm and basically eliminate any significant chance of recession in coming quarters, leaving only the likelihood of modest economic growth at worst.
Year-on-year, personal income is up 6.8 percent in August while the wages & salaries component is up 7.1 percent.
Despite the stock market decline in early August and the credit crunch in some sectors, the consumer remained positive as personal consumption increased 0.6 percent in August, reflecting a 2.4 percent jump in spending on durable goods, specifically autos.
There was very good news on inflation as the PCE price core index rose only 0.1 percent with the year-on-year rate up only 1.8 percent, the lowest in 3-1/2 years and under the Federal Reserve's 2 percent comfort limit for the third straight month. The overall price index fell 0.1 percent and is also at a 1.8 percent year-on-year pace.
Both existing and new home sales continue to spiral downward. Existing home fell another 4.3 percent in August to a 5.50 million annual rate. Year-on-year, sales are down 12.8 percent. The worst news, however, is a new record of supply, at 10.0 months, meaning that there is no reason for homebuilders to ramp up construction anytime soon. Existing homes on the market compete with new homes, meaning that homebuilders have more than just new home supply to worry about. The median price showed some erosion, down to $224,500 for a 1.8 percent dip in the month. But the year-on-year price still shows firmness, up 0.2 percent and perhaps reflecting reluctance among homeowners to sell at a discount. But with supply expanding, further declines in home prices are likely.
Housing continues its free fall with new home sales dropping a whopping 8.3 percent in August to an annual rate of 795,000 from a downwardly revised July rate of 867,000. Year-on-year sales were down 21.2 percent in the month. Weakness was in the South and West, which declined 14.7 percent and 20.8 percent respectively. Sales nationwide were hurt by the August credit crunch but the West region was particularly hard hit by the lack of liquidity for jumbo loans. The Northeast and Midwest actually posted gains of 42.3 percent and 20.5 percent, respectively.
As with existing home sales, the biggest problem with new homes on the market is the jump in supply which rose sharply to 8.2 months from 7.6 months in July. Builders clearly need to cut back on construction and start thinking about some heavy price discounting. That discounting may have already started as the median sales price fell 8.3 percent in August to $292,000 from $306,200 in July. The median sales price is down 7.5 percent year-on-year. The bottom line is that housing has a long way to go before recovery begins.
While housing is in recession, other parts of the construction sector are doing well. Construction spending showed life in August, rebounding 0.2 percent, following a 0.5 percent decline the previous month. As has been the story all year, non-residential construction and public sector construction continue to offset the decline in the residential component. Non-residential private construction, led by office construction, jumped 2.3 percent in the month. Public construction has also been helping, up 0.7 percent in the month and showing another strong month in educational construction.
Overall construction is down 1.7 percent year-on-year. By components, private residential is down 16.5 percent while private nonresidential and public outlays are up 15.2 percent and 18.3 percent, respectively. Given the huge inventories of unsold homes, it is going to be months before housing starts strengthen and eventually boost residential outlays. In the meantime, the nonresidential and public sector components are keeping overall construction from any notable declines.
Manufacturing hit a bump in the road in August as durables orders retreated. Durable goods orders posted a sharp 4.9 percent drop in August, following a 6.1 percent surge in July. Durable goods orders in August appear at first blush to be very bad. But weakness is mainly in aircraft. Outside of aircraft, weakness largely reflects coming off a sharp increase in August and the two months on average are moderately positive. Excluding the volatile transportation component, new orders dipped 1.8 percent in August, following a 3.4 percent jump the month before. But the durables data are very volatile and should be viewed over several months. On average, July and August data remain moderately healthy across nearly all major components.
Backlogs indicate that there is still notable forward momentum in manufacturing. Unfilled orders rose 1.2 percent in August, following a 2.4 percent jump in July. Unfilled durables orders came in at up 21.9 percent year-on-year in August, compared to up 20.9 percent in July.
The latest GDP numbers changed little from the prior estimates. For the second revisions to second quarter GDP, real GDP was revised down to an annualized 3.8 percent from the previous estimate of 4.0 percent. The downward revision to GDP was primarily due to a downward revision to net exports. The second quarter GDP price index was revised down marginally to 2.6 percent from the prior estimate of 2.7 percent. The core PCE price index was revised up slightly to 1.4 percent from the prior estimate of 1.3 percent but was still lower than the first quarter's 2.4 percent.
The key point from the final revision to the GDP numbers is that the economy had substantial momentum going into the turbulent third quarter. And despite weakness in housing, third quarter GDP is still likely to be well over 2 percent annualized, further supporting the argument that the economy is getting past all of the credit crunch problems without suffering too much damage.
This past week, Fed officials commented on the recent cut in the fed funds rate target and on the likelihood of further cuts. First, Atlanta Federal Reserve Bank President Dennis Lockhart indicated that at the September FOMC meeting the Fed had to choose between concerns over the overall economy versus morale-hazard issues, and it was concern over the economy that was the reason for the cut in interest rates. This was an indication that despite moaning by some financial commentators about the Fed “bailing out” cavalier and high-risk-taking subprime lenders, that the Fed is still concerned about morale hazard which could slow the timing or magnitude of rate cuts. But Lockhart also said the Fed has made progress on inflation – an indication that there is room for further rate cuts.
San Francisco Fed President Janet Yellen, speaking on behavioral economics at a conference in Boston sponsored by the Boston Fed, only indirectly addressed monetary policy. Indirectly, she indicated that expectations are important for policy — that is, the Fed must maintain a credible anti-inflation stance. This was a reminder that this Fed is not likely to be quick to be loose with easy money.
The biggest comments came from St. Louis Federal Reserve Bank President William Poole. He specifically focused on the fact that the Fed is still concerned about both inflation and sluggish economic growth. The St. Louis Fed president stated that the Fed has to keep an open mind on the next policy move. Poole sees a gradual decline in inflation over the next few years with economic growth moderate. The most pointed remark by Poole on monetary policy was that it might be a mistake for the markets to assume a series of rate cuts by the Fed. While Poole was speaking for himself, this remark likely reflects the views of at least most of the FOMC. The bottom line is that the Fed is remaining flexible about what the appropriate monetary policy should be in coming months.
Outside of housing, the economy remains reasonably healthy. The consumer and manufacturing sectors are holding up and core inflation currently is behaving. Nonetheless, the Fed remains concerned about both upside and downside risks to the economy. Even if the Fed is a little more cautious about interest rate cuts than most apparently are hoping, the economy remains on a moderate upward path outside of housing. While not yet articulated heavily in public by Fed officials, the Fed is certainly worried about high oil prices, the declining dollar, and tight labor markets. These are issues likely to be addressed in the still-to-be-released minutes of the September 18 FOMC meeting.
This coming week gives us new information on manufacturing and auto sales but the highlight will be the September jobs report due out on Friday, which could tip the balance on whether or not the Fed will ease again at the end of its October 30-31 FOMC meeting. Fed Speak last week indicated that the markets would be wise to assume nothing about the next policy moves by the Fed other than that the Fed would let incoming economic data and market conditions dictate policy, which is all the more reason to pay attention to the data.
The Institute for Supply Management’s manufacturing index dipped from 53.8 in July to 52.9 in August, bringing into question whether the manufacturing sector is still doing its part to keep the economy out of recession. The August number was still in positive territory but not by a lot. Given the reversal in new orders for durable goods in August after a strong July, the Fed likely will be giving the more current manufacturing surveys more attention than usual, heading into its October 30-31 policy meeting. But as of August, the ISM manufacturing report suggested continuing but slowing forward momentum as new orders and backlogs edged down within positive territory. Markets will be looking to see if the exports index continues to improve as is likely due to the declining dollar.
ISM manufacturing index Consensus Forecast for September 07: 52.9
Range: 51.0 to 54.0
Motor vehicle sales proved surprisingly strong in August despite all of the market turmoil, coming in at a 12.6 million annual rate for domestic-made vehicles, compared to 11.4 million in July. Sales of trucks were especially strong, at a 7.5 million rate and the best rate since February. With uncertainty on how consumer confidence is holding up after the subprime impact on the stock markets and on lending standards, the September motor vehicle sales number will be an important indicator of whether the consumer is still willing to spend. This is a critical issue since if either rising mortgage payments or loss of consumer confidence cut into auto sales, that could be an early warning of flattening economic growth overall. Motor vehicle sales are clearly a key bellwether for turns in the business cycle.
Motor vehicle sales Consensus Forecast for September 07: 12.4 million-unit rate
Range: 12.0 to 12.6 million-unit rate
The business activity index from the ISM non-manufacturing survey was unchanged in August, at a very solid 55.8 that points to steady economic growth through the second half of the year. But since that report, we have had notable swings in durables orders and the Fed will continue to cull as much anecdotal and industry data as possible before making its next monetary policy vote.
Business activity index Consensus Forecast for September 07: 54.5
Range: 54.0 to 56.4
Initial jobless claims continued to portray a tight labor market as claims fell 15,000 in the week ending September 22 to 298,000. The latest four week average declined for the second week, to 311,400 and back down to mid-summer levels.
Jobless Claims Consensus Forecast for 9/29/07: 310,000
Range: 306,000 to 315,000
Factory orders surged in July, jumping 3.7 percent and led by an 11.0 percent spike in transportation orders, including both strong aircraft orders and motor vehicle orders. But there was plenty of strength outside of aircraft and vehicles, with orders excluding transportation up 2.4 percent. But more recently, new factory orders for durables – the largest component in factory orders – fell a sharp 4.9 percent in August, following a 6.1 percent surge in July. Usually the factory orders report does not get much attention because most of the data are already known from the durables report. But with the August durables number largely offsetting the July boost, the markets may actually be paying attention to whether the durables component is revised up or down in the overall report.
Factory orders Consensus Forecast for August 07: -2.8 percent
Range: -3.6 to -2.0 percent
Nonfarm payroll employment rattled the markets last month with the August decline in payroll jobs of 4,000 and with downward revisions to the prior two months. The markets will look to see if the dip in August was temporary or whether job growth resumes. This report certainly will play a key role in whether the Fed eases again on October 31. Strong numbers for initial unemployment claims suggest that employment is likely to return to positive growth in September. On a technical note, some of the weakness in the July and August reports was for education workers and that category can have some unusual swings from the end of the school year through the start of the school year due to seasonal adjustment difficulties. So, we may get a reversal in what was likely technical weakness in education workers. On the inflation front, average hourly earnings increased 0.3 percent in August, matching the pace in July. The civilian unemployment rate was unchanged at 4.6 percent in August, indicating continued tightness in the labor market.
Nonfarm payrolls Consensus Forecast for September 07: 115,000
Range: 50,000 to 147,000
Unemployment rate Consensus Forecast for September 07: 4.7 percent
Range: 4.5 to 4.7 percent
Average workweek Consensus Forecast for September 07: 33.8 hours
Range: 33.8 to 33.9 hours
Average hourly earnings Consensus Forecast for September 07: +0.3 percent
Range: +0.2 to +0.3 percent
Consumer credit rose $7.4 billion in July, a big increase but down from a very swollen $12.0 billion in June. Revolving credit rose $5.0 billion in the month with a rise in non-revolving credit making up the balance. August data for consumer credit will be difficult to read due to the seizing of liquidity in a number of markets that month. But the month will be a baseline for whether credit markets are improving when September data come out.
Consumer credit Consensus Forecast for August 07: +$9.5 billion
Range: +$3.1 billion to +$10.0 billion
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