While indicators were mixed this week, two clearly were on the upside. Housing starts came in above expectations and new orders for durable goods excluding transportation were especially positive. Initial unemployment claims rose somewhat while the index of leading indicators slipped. Net, the markets decided that the economy is a little stronger than previously believed -- notably that housing is not falling out of bed and manufacturing remains strong. The positive indicators reinforced the belief that the Fed is in a tightening mode and despite the positive economic news, the Fed's shadow continued to keep the markets queasy despite very little Fed speak this week. Changing market psychology played a big role in equities each day this week and notably so on Thursday for bonds. Stocks started down on Monday, posted large mid-week gains, but ended the week down. Interest rates jumped on Thursday and remained that way through Friday's close.
Recap of US Markets
STOCKS
Stocks began the week by posting losses on Monday, following a repeat of an earlier speech by outgoing Atlanta Fed President Jack Guynn. There was no new news but the markets did not like being reminded of pending Fed interest rate increases. On Tuesday, the better-than-expected housing starts numbers helped lift the Dow but interest rate fears kept the gain soft and actually led other major indexes down for the day. With no economic releases and no Fed speak, company news stood out on Wednesday. Stocks jumped as a result of FedEx delivering very strong earnings as did Morgan Stanley. These set the tone for the day. On Thursday, despite favorable earnings the day before, market psychology turned pessimistic, focusing on slowing economic growth and higher interest rates. All major indexes dropped as earnings reports were on the negative side and one major investment management firm announced a projection for fed funds to hit 6 percent this tightening cycle. Merger activity in the energy sector gave major indexes a modest boost early on Friday but with the exception of the Russell 2000, major indexes ended the day in negative territory due to interest rate concerns and greater realization that the economy is slowing.
For the week, four key indexes were down: the Dow, 0.2 percent; S&P 500, 0.6 percent; Nasdaq, 0.4 percent; and the Russell 2000, 0.4 percent.
BONDS
Rates rose significantly this week. Fed tightening remains the key focus. The biggest rate gains occurred Thursday and Friday after speculative talk of 6 percent fed funds. Talk of 6 percent fed funds probably was over played -- especially because Fed officials have recently been indicating that monetary policy is close to where it should be. Rates on the yield curve rose almost evenly by between 8 to 11 basis points.
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
Housing starts surprise
Housing starts rose 5.0 percent in May to an annualized pace of 1.957 million units from April's revised 1.863 million unit pace. May's starts came in a little above the consensus expectation of 1.87 million units. Starts are 3.8 percent below May 2005 levels. Permits, however, slipped 2.1 percent to 1.932 million units from April's 1.973 million units. Permit levels point to moderation in housing activity but remain at healthy levels.
May's strength in starts was primarily in multifamily units which rebounded 19.7 percent while single-family units rose a more moderate 2.1 percent. Regionally, starts were strongest in the West and South, up 15.8 percent and 8.5 percent, respectively. In the Northeast, starts edged up 1.7 percent but fell 15.8 percent in the Midwest.
May's housing numbers were a boost to those with the view that housing is on a moderate downtrend instead of one that is on a sharp decline. Underlying fundamentals are softer than a year ago but still healthy. Income growth and wealth effects from earlier stock market gains have been moderating the impact of higher mortgage rates -- which by historical standards are still significantly lower for this phase in the business cycle.
The level of housing starts remains healthy. However, the mild downturn in starts will gradually show up in somewhat negative growth for residential investment in real GDP and also in slower growth in household durables.
Durable orders mixed -- momentum continues
Headline durable goods orders slipped 0.3 percent in May after a sharp 4.7 percent drop in April. Declines in May were led by a 2.6 percent drop in transportation equipment - primarily non-defense aircraft. But importantly, excluding transportation, new orders rebounded 0.7 percent following a 1.0 percent drop in April. The ex-transportation figure was seen as a clear positive by the markets. Nondefense capital goods orders fell 1.9 percent in May after a 6.3 percent drop in April and an 11.6 percent surge in March.
Industry categories showing declines in May were fabricated metal products, 1.3 percent; computers & electronic parts, 1.1 percent; electrical equipment, 0.2 percent; and transportation, 2.6 percent. Gains were seen in primary metals, 3.5 percent; machinery, 2.3 percent.
Overall inventories rose 0.4 percent in May -- the fourth gain in five months. Overall shipments rebounded 2.6 percent while unfilled orders rose 0.6 percent. While new orders for non-defense capital goods were soft in May, shipments were not, rising 2.1 percent. These shipments point to a healthy gain in producers durable equipment for second quarter GDP.
The continued rise in unfilled orders suggests that momentum in manufacturing remains healthy. Weakness in new orders recently has been in non-defense aircraft and these orders are slow to fill. New orders excluding transportation have been healthy with unfilled orders posting significant gains in recent months. A caveat regarding this momentum is that if the economy softens too much in coming quarters, some orders will be canceled.
Leading indicators point to slower growth
The Conference Board's index of leading economic indicators fell 0.6 percent in May following a 0.1 percent decline in April. The index, based on a mix of economic and financial data, is pointing to what the Conference Board said is slow to moderate economic growth ahead. Pressuring the index the most in May was the jump in jobless claims and the dip in consumer confidence, with positive factors headed by capital goods orders and consumer goods orders.
The Bottom Line
The latest economic data are very much in line with earlier expectations about the strength and direction of the economy. This week's housing data were only a little stronger than expected but still point to moderation as permits have edged down. The Conference Board's index of leading indicators was a little soft but with weakness concentrated in initial claims and with no really new information. Manufacturing momentum remains intact as weakness in new orders was primarily in the lumpy and volatile non-defense aircraft component. Excluding transportation, new orders for durables point to continued moderately strong growth in manufacturing. On the equities front, companies continue to come out with mixed earnings forecasts but with sectoral strengths and weaknesses largely tied to the direction of sectoral strengths and weaknesses in the overall economy.
The Fed is almost certain to raise interest rates next week and the markets put odds at slightly better than 50 percent for another increase in August. Recent talk of 6 percent fed funds is hugely speculative at this point with few taking that position. Fed funds going to 6 percent does not match Fed officials' recent commentary that interest rates are near to where they need to be. Essentially, the economy remains on track with only slightly higher interest rates at worst. The forecast is still for a moderately healthy consumer sector, strong business investment, healthy net exports, but with a slowing housing sector.
Looking Ahead: Week of June 26 to June 30
Monday
New single-family home sales proved stronger than expected in April, up 4.9 percent to an annual rate of 1.198 million units vs. expectations for 1.150 million. Supply on the market fell back to 5.8 months at the current sales rate, down from 6.0 months in the March data and 6.4 months in February. Declining supply relative to sales points to rising prices.
New home sales Consensus Forecast for May 06: 1.145 million-unit rate
Range: 1.100 to 1.210 million-unit
Tuesday
Existing home sales fell back as expected in April, down 2.0 percent to an annual unit rate of 6.76 million. The dip was evenly split between the dominant single-family home category, down 2.0 percent to 5.92 million, and condos, down 2.7 percent to 839,000.
Existing home sales Consensus Forecast for May 06: 6.65 million-unit rate
Range: 6.50 to 6.88 million-unit rate
The Conference Board's consumer confidence index fell sharply in May to 103.2 from 109.8 in April. The decline reflected the effects of high gas prices, but job readings also deteriorated. One big negative was a sharp decline in overall consumer expectations, down to 83.7 from 92.3 in April.
Consumer confidence Consensus Forecast for June 06: 104.0
Range: 101.0 to 105.0
Thursday
Real GDP was revised upward for the first quarter to an annual growth rate of 5.3 percent from an advanced reading of 4.8 percent. The higher growth rate was due primarily to upward revisions in inventory growth and in exports, rising $30.4 billion, compared to the initial estimate of $25.7 billion. Final sales were nudged up to 5.5 percent from an advanced 5.4 percent.
The core deflator for PCEs was unchanged from the advance reading of 2.0 percent. The overall GDP deflator also was unchanged from the initial 3.3 percent figure.
Real GDP Consensus Forecast for final Q1 06: 5.6 percent annual rate
Range: 5.4 to 5.8 percent annual rate
GDP deflator Consensus Forecast for final Q1 06: 3.3 percent annual rate
Range: 3.3 to 3.4 percent annual rate
New jobless claims Initial jobless claims, which last week hit a four-month low, popped back up in the June 17 week, rising 11,000 to a still mostly as expected 308,000 to indicate steady but less-than-robust conditions in the nation's jobs market. There were no special factors in the week's data.
Jobless Claims Consensus Forecast for 6/22/06: 310,000
Range: 300,000 to 315,000
Friday
Personal income rose a healthy 0.5 percent in April following a 0.5 percent boost in March. Wages and salaries rose 0.9 percent in April, following a 0.5 percent gain in March. Personal consumption for April rose 0.6 percent, following a 0.5 percent increase the prior month. For prices, the overall PCE deflator rose a strong 0.5 percent with the core PCE up a more moderate 0.2 percent. Year-on-year rates showed a 2.9 percent gain for the overall reading, with the core up one tenth to 2.1 percent, at the high end of trend and at the upper limit that Federal Reserve officials point to.
Personal Income Consensus Forecast for May 06: 0.2 percent
Range: 0.1 to 0.5 percent
Personal Consumption Expenditures Consensus Forecast for May 06: 0.4 percent
Range: 0.2 to 0.5 percent
The University of Michigan's consumer sentiment index edged up to 82.4 in the first two weeks of June from the very low 79.1 reading in May that was hit hard by gas prices. A big negative in the report is the still very wide separation between current conditions, at 103.1, vs. expectations at 69.2. Low expectations relative to current conditions point to falling overall confidence in the months ahead.
University of Michigan Consumer Sentiment index Forecast for June: 82.5
Range: 80.5 to 83.0
The NAPM-Chicago's main index showed a sharp acceleration in business conditions during May with a jump to 61.5 from 57.2 in April. New orders and backlog orders were up while production softened although remaining positive.
NAPM-Chicago Consensus Forecast for June 06: 59.0
Range: 56.0 to 60.5
Economy Surprises on Upside But Markets Fear Slowing
