Data on the economy were mixed this week, but mostly softer. The key exception was the CPI release which indicated consumer inflation is exceeding the Fed's speed limit. As expected, the consumer sector is moderating as reflected with softer retail sales. Manufacturing is mixed with industrial production edging down in May but with regional manufacturing surveys giving divergent signals for June. The New York Fed found manufacturing to be strengthening while the Philly Fed found softening. In the context of earlier data on orders backlogs and recent strength in a number of industries, manufacturing remains healthy. However, the big economic news is the core CPI which posted a 0.3 percent boost in May - the third consecutive increase of this magnitude.
The Fed was the other key news item. The week began with the markets having just been sobered by Chairman Bernanke's comments that recent inflation trends are unacceptable if continuing. On Monday, Cleveland Fed President Pianalto delivered another soliloquy on the need for pre-emptive action against rising inflation expectations. Chairman Bernanke spoke again on Wednesday, essentially giving a classroom presentation on the impact of higher energy prices on transitory and on underlying inflation and also on the Fed's determination to keep inflation constrained. Notably, Bernanke also stated that energy's impact on inflation is "manageable."
On Friday, St. Louis Fed President Poole chimed in on the chorus, further detailing how he sees the Fed on maintaining price stability and economic growth but with the key caveat that economic growth is best sustained with low inflation. The Fed's message clearly seems to be that the Fed is making its case for continued vigilance and possible rate hikes to lower inflation expectations and bring core inflation back to a preferred path. These recent policy "lessons" by the Fed members certainly mean another rate hike during the June 28-29 FOMC but also may mean one more in August to possibly let the Fed onto the sidelines heading into the mid-term elections.
Recap of US Markets
STOCKS
Stocks took a roller coaster ride this week. Major indices dove Monday and Tuesday as a result of fears over further Fed tightening. The Dow fell 99 points on Monday and 86 points on Tuesday. The early in the week losses were heavily motivated by Cleveland Fed President Pianalto's remarks. Some also believe that technical factors related to institutional investors adjusting long-term derivative positions may have been behind some of the selling.
By Wednesday, Bernanke's comments on energy cost impact on inflation being manageable gave buyers confidence. Many also saw equities as oversold and buyers believed they saw many bargains. All major indexes showed sizeable gains during Wednesday and Thursday. The Dow saw its largest gains in a year over this two-day period. Wednesday's Beige Book also gave many investors the impression that despite energy costs and higher interest rates, the economy remains quite resilient. Earnings outlooks also improved on Wednesday. On Thursday, lower jobless claims also supported the bulls.
Friday, pessimism again settled in with only the Dow among major U.S. indexes not posting notable declines. Poole's comments again sobered the markets regarding pending Fed increases in interest rates. Additionally, weaker gains in foreign net purchases of U.S. Treasuries raised fears of a weaker dollar, higher inflation, and higher interest rates. Sellers were worried the Fed will go too far with rate increases.
For the week, the Dow posted a moderate net gain of 1.1 percent while the S&P 500 and Nasdaq were essentially flat. The Russell 2000 declined by 1.2 percent.
BONDS
Except for the 3-month bill, the yield curve rose significantly this week due to concerns over Fed tightening and due to a softening in foreign net purchases. Rates on 2-year notes on through the 30-year bond rose almost evenly by between 15 to 17 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
RETAIL SALES REMAIN SOFT
Overall sales rose 0.1 percent in May, following a 0.8 percent jump in April. With the recent importance of price effects on gasoline and overall sales, it is notable that gasoline sales rose 1.9 percent in May, after surging 5.5 percent in April. Excluding gas station sales, retail sales for May slipped 0.1 percent, compared to a 0.3 percent rise in April. Year-on-year, overall sales are up 7.6 percent, compared to 7.1 percent in April. Excluding gas station sales, May's year-on-year gain is 6.1 percent versus April's 5.9 percent increase.
Motor vehicle sales fell 1.6 percent in May following April's 0.8 percent rise. Excluding motor vehicles, retail sales posted a 0.5 percent increase in May, following a 0.8 percent boost in April. The consensus had expected a 0.5 percent gain in retail sales excluding motor vehicles. A clearer picture of underlying trends can be seen by excluding both motor vehicles and gasoline sales categories. Overall sales excluding both motor vehicle and gasoline sales increased 0.3 percent in May, following a 0.1 percent rise in April.
May's retail sales report is consistent with the view that the consumer sector is beginning to moderate. Clearly, higher energy bills, slower housing appreciation, and higher interest rats (plus higher minimum credit card payments for some consumers) are beginning to slow the consumer sector. Nonetheless, there are no sign of anything other than softening as employment and income growth remains on a reasonably healthy trajectory.
CPI CONTINUES TO HEAT UP
Overall consumer price inflation rose 0.4 percent in May, following a 0.6 percent jump in April. Again, inflation at the consumer level is running much stronger than at the producer level. Notably, the CPI showed continued pressure at the core level, rising a strong 0.3 percent in May, following a 0.3 percent boost in April. Core inflation has been at 0.3 percent for three months in row. Year-on-year core inflation growth is now at 2.4 percent, compared to 2.3 percent in April and well above the 1.6 percent growth rate for the core PPI. The core CPI rate is also beyond the Fed's perceived 2.0 percent upper limit for inflation and a likely 1.5 percent preferred inflation rate. The overall CPI's year-on-year growth rate is now 4.2 percent.
MAY PPI MIXED
Producer prices rose 0.2 percent in May, following a 0.9 percent surge in April. Excluding energy prices, the PPI edged up 0.1 percent in May, following a 0.1 percent increase in April.
The core rate, which excludes both energy as well as food, rose a stronger 0.3 percent in May, following a 0.1 percent rise in March. The year-on-year core rate, a closely watched barometer for underlying inflation, came in at a modest 1.5 percent. In contrast, the overall year-on-year rate was 4.5 percent. This divergence is indicative of the concern of at least some FOMC members that high energy costs will eventually boost underlying inflation for consumers.
Inflation at lower levels of production continues to be a concern. Overall prices at the crude level of production rose 2.0 percent in May while prices at the intermediate level rose 1.1 percent
INDUSTRIAL PRODUCTION DIPS IN MAY
Industrial production softened in May, edging down 0.1 percent, following strong gains of 0.5 percent in March and 0.8 percent in April. By components for May, manufacturing slipped 0.1 percent while mining and utilities declined 0.2 and 0.1 percent, respectively. Manufacturing weakness was led by machinery, motor vehicles, electrical equipment, apparel, printing, and chemicals. Gains were led by primary metals, computers, and petroleum products. Overall manufacturing output is up 4.9 percent year-on-year.
Capacity utilization in manufacturing remains moderate, edging down to 80.5 percent in May from 80.8 percent in April. Despite the softness in May, the industrial sector is still expected to provide moderate growth for the U.S. economy this year.
NEW YORK FED'S MANUFACTURING INDEX STRENGTHENS IN JUNE
The Empire State manufacturing report, often volatile, popped up sharply and surprisingly in June to 29.0 vs. 12.9 in May. New orders, at 25.8 vs. 16.2, were very strong as were unfilled orders which rose to 9.4 vs. 2.8. The Empire State report has been proving stronger than other regional manufacturing surveys and stronger than the national report from the ISM. So strength in the report may not be that surprising but its price readings are certain to capture attention. The prices paid index rose very sharply to 52.9 from 43.1, with prices received, reflecting price hikes successfully passed through to customers, at 19.0 vs. 14.6.
PHILADELPHIA FED'S MANUFACTURING INDEX REMAINS POSITIVE IN JUNE
The Philadelphia Federal Reserve's business activity index came in at a solid 13.1 in June versus 14.4 in May. A very big plus in the Philadelphia data was a very big jump in new orders to 17.7 from 2.7 in May. Price readings continued to show strains with prices paid at 48.7, vs. 55.3 in May, and prices received at 14.0, up from 10.3.
BUSINESS INVENTORIES SLOW IN APRIL
Business inventories rose 0.4 percent in April, held down by a 0.2 percent decline in retailer inventories. Factory inventories rose 0.7 percent while wholesaler inventories, the smallest of the three categories, rose 0.9 percent. Given signs of slowing economic growth, including from the latest retail trade report, the 0.4 percent overall rise is a welcome slowdown from the 0.7 percent gain in March.
The Bottom Line
The economy is moderating mostly as has been expected. The consumer sector is softening but still healthy. Business investment and industrial production remain positives. However, there is clear concern at the Fed that in coming quarters real growth is a little too strong, actual inflation is already too high, and inflation expectations have risen. Now there is additional talk by some FOMC members that money growth is on the high side. Financial markets see potential problems with softening in foreign demand for U.S. Treasuries unless interest rates are nudged up. The bottom line is that the Fed is preparing to take a firm but measured stand against inflation. Slower real growth must be a part of the outlook and inflation expectations will have to be brought down before the Fed enters an easing phase - or rather a return to a neutral policy stance. Regardless, there is no indication by the Fed that such policy actions need to be dramatic. In fact, many FOMC members have indicated that interest rates are near to where they need to be and Bernanke described energy-based inflation problems as "manageable." However, what the Fed sees as slower real growth also likely will be moderately healthy growth.
Looking Ahead: Week of June 19 to June 23
Tuesday
Housing starts fell 7.4 percent in April by to an annualized pace of 1.849 million units from March's revised 1.996 million unit pace. Starts are 11.1 percent below April 2005 levels. Permits also posted a decline, down 5.4 percent to 1.984 million units from March's 2.097 million units.
Housing starts Consensus Forecast for May 06: 1.870 million-unit rate
Range: 1.800 to 2.000 million-unit rate
Thursday
New jobless claims fell 8,000 in the June 10 week to a much lower-than-expected total of 295,000, the first sub-300,000 reading since February. The Labor Department said there were no special factors in the week. The decline pushed down the 4-week average by a sharp 12,250 to 315,750 but still a level consistent with only moderate payroll growth.
Jobless Claims Consensus Forecast for 5/27/06: 305,000
Range: 300,000 to 330,000
The Conference Board's index of leading economic indicators slipped 0.1 percent in April. March was revised sharply higher to a 0.4 percent gain from an initial 0.1 percent decline. Despite the March revision, the report so far this year has been mostly signaling flat conditions ahead.
Leading indicators Consensus Forecast for May 06: -0.5 percent
Range: -0.7 to -0.1 percent
Friday
New orders for durable goods Durable goods orders fell 4.4 percent in April, following a sharp 6.0 jump in March. Unfilled orders for durables continue on a healthy upward trend, rising 1.5 percent in April, following a 3.0 percent boost in March. Unfilled orders for durables are up 22.4 percent on a year-on-basis.
New orders for durable goods Consensus Forecast for May 06: 0.4 percent
Range: -2.5 to 2.5 percent
Economy Mostly Softens but Fed Speaks Out
