The Fed took center stage this week with little economic data to distract. Early in the week Chairman Bernanke unsettled the markets with comments that recent core inflation readings are not acceptable if they continue and also that inflation expectations have risen. These comments led the market to reevaluate the latest FOMC minutes to be more on the hawkish side. Speeches by St. Louis Fed president William Poole and Atlanta Fed president Jack Guynn also confirmed that FOMC members are focusing on the fact that core inflation is at or a little above the Fed's comfort zone and that the FOMC is concerned about not letting inflation get out of hand.
Interest rates have firmed since these comments and fed funds futures are now back to pricing in higher interest rates in the near-term. The stock market has slipped in recognition that interest rate costs and a slowing economy are going to moderate profit growth. Nonetheless, there is not a 100 percent consensus that the Fed will tighten at the end of June, given the possibility that this week's economic numbers could still give the Fed reason to pause.
While the regional bank presidents have emphasized that policy decisions are now on a meeting-by-meeting basis, it is beginning to become clearer that the Fed is moving closer to inflation targeting and that the core inflation numbers suggest that a modest tightening is appropriate. Based on historical relationships, a neutral monetary policy stance would put fed funds near 4-1/2 percent. As such, the Fed may now be in a mild tightening stance, reflecting a desire to bring core inflation back nearer 1-1/2 percent. What is best, raise rates or pause' Pausing will leave considerable uncertainty whereas an increase at the end of June and even perhaps in August would be viewed as the end of the tightening cycle. Tightening now and reducing uncertainty is likely the preferred course by the Fed. Even though this year's elections are merely mid-term elections, the Fed certainly would like to be well on the side lines by November.
Recap of US Markets
STOCKS
Due to inflation fears and further Fed tightening, U.S. stocks had their worst week since April 2005. All major indices ended the week down significantly. The Russell 2000 fell a sharp 4.9 percent for the week while the Dow, S&P 500, and Nasdaq fell 3.2 percent, 2.8 percent, and 3.8 percent, respectively. Industries dependent on commodity prices for revenues were particularly hard hit. Technology did provide some support within the Nasdaq.
BONDS
The yield curve flattened slightly this week as the 3-month T-bill and especially the 2-year T-note rose on concerns over Fed tightening. The 2-year T-notes had its largest weekly drop in price since March of this year. The 2-year note is particularly sensitive to policy changes. However, Fed resolve on the inflation front can be seen as favorable for the long end.
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
April trade deficit widens
The U.S. trade gap widened in April to $63.4 billion versus expectations for $65.0 billion and
compared to a $61.9 billion gap in March. Imports rose 0.7 percent while exports fell 0.2 percent. Importantly, we have yet to see the full effect of the recent oil spike. Curiously, we may see a sharp widening in current dollars over the next few months while in real terms the widening could slow. We may be seeing more of price and income effects from the trade sector helping to moderate real growth in the overall economy even as the trade gap in real terms decelerates and technically adds to the real GDP numbers.
Import prices continue strong gains
Import prices rose 1.6 percent in May, a jump that follows a 2.1 percent spike in April and one that will raise concern over next week's PPI and CPI reports. The last two months of gains are the sharpest in 16 years! A sudden jump in non-fuel import prices may even be a bigger concern, up 0.7 percent in the month and a shift that raises questions whether energy prices have finally begun to feed through. Export prices were also higher, up 0.7 percent in the month following a 0.6 percent rise in April.
The Bottom Line
Economic indicators were relatively sparse this week and the Fed and foreign central banks were the key focus of the markets. Comments by Fed Chairman Bernanke and regional Fed presidents shifted the market perception to a view that the Fed will make its 17th rate hike in the current tightening cycle at the end-of-June FOMC meeting. Economic data for this week can help finalize the case for another rate increase. The economic indicator news after this coming week and prior to the June FOMC are not as important for changing views on the strength of the economy. Fed members have indicated they are making policy decisions on a meeting-by-meeting basis, and this upcoming week's data are the key indicators remaining until the next FOMC.
The upcoming week will see bevy of key data - including retail sales, inflation, and production numbers.
Looking Ahead: Week of June 12 to June 16
Monday
Treasury Statement Consensus Forecast for May: -$39.0 billion
Range: -$40.0 billion to -$25.0 billion
Tuesday
Retail sales rose 0.5 percent overall but were boosted by a huge 4.6 percent surge in gasoline sales that of course reflected inflated pump prices. Excluding gas station sales, retail sales for April were up a mere 0.1 percent, this compares with a 0.7 percent gain in March. More recently, chain stores sales have been healthy but these are only a moderate portion of overall retail sales. A strong retail sales figure for June - once gasoline price effects are discounted - could be more fodder for another Fed hike this month. Will the consumer sector be moderating or come in strong and be a concern for the Fed'
Retail sales Consensus Forecast for May: +0.0 percent-no change
Range: -0.3 to +1.0 percent
Retail sales excluding motor vehicles Consensus Forecast for May: +0.5 percent
Range: +0.3 to +0.8 percent
The producer price index shot up 0.9 percent in April but excluding energy prices inched only 0.1 percent higher. Commodity prices have shown weakness recently but too late to have an impact on the data. Even so, commodity prices have only a minor impact on the headline PPI for finished goods.
PPI Consensus Forecast for May: +0.5 percent
Range: -0.2 to +0.7 percent
PPI excluding food & energy Consensus Forecast for May: +0.2 percent
Range: +0.1 to +0.3 percent
Business inventories rose a higher-than-expected 0.7 percent in March, the same rate as business sales keeping the stocks-to-sales ratio at 1.26.
Business inventories Consensus Forecast for April: +0.6 percent
Range: +0.3 to +0.9 percent
Wednesday
The consumer price index rose 0.6 percent in April to a year-on-year rate of 3.5 percent. The core CPI showed more pressure, rising a hot 0.3 percent for a second straight month that put the year-on-year rate at 2.3 percent, vs. 2.1 percent in March and beyond the 1.5 percent level for the PPI. The rate is also beyond the Fed's 2.0 percent outer comfort zone. Markets have begun to focus on housing costs, but that component changes slowly. The real issue is whether higher oil prices will boost non-energy, non-food goods prices, and it this part of the CPI that the Fed will like give extra attention for measuring basic inflation pressure. Another 0.3 percent boost in the core rate would be a near-clincher for another rate hike at month end.
CPI Consensus Forecast for May: +0.4 percent
Range: +0.2 to +0.5 percent
CPI excluding food & energy Consensus Forecast for May: +0.2 percent
Range: +0.2 to +0.3 percent
Thursday
New jobless claims for the May 27 week rose by 7,000 to a larger-than-expected total of 336,000, pushing up the four-week average to 333,500 which is the worst level since hurricane-inflated totals in October. There were no special factors in the latest week.
Jobless Claims Consensus Forecast for week of June 10: 320 K
Range: 305 K to 335 K
The New York Fed's Empire State Manufacturing Survey index slipped in May to 12.4 from 15.8 in April
Empire State Manufacturing Survey Consensus Forecast for June: 12.0
Range: 4.6 to 16.0
The index of industrial production showed surprising strength in April, rising 0.8 percent vs. a solid 0.6 percent gain in March and a revised 0.4 percent rise in February. More recently, aggregate hours in manufacturing fell 0.3percent, suggesting a weak industrial production number for May. Manufacturing surveys show modest forward momentum with the surveys from Philadelphia, New York, and Richmond Feds having mild positives with only the Kansas City Fed survey showing notable strength.
Industrial production Consensus Forecast for May: +0.2 percent
Range: -0.1 to +0.4 percent
Capacity utilization Consensus Forecast for May 06: 82.0 percent
Range: 81.7 to 82.1 percent
The Philadelphia Fed's Business Outlook Survey general activity index edged higher in May to 14.4 from 13.2 in April.
Philadelphia Fed Manufacturing Survey Consensus Forecast for June: 11.0
Range: 3.5 to 18.0
Friday
The University of Michigan Consumer Sentiment index fell sharply to a mid-May reading of 79.0 vs. 87.4 in April.
University of Michigan Consumer Sentiment index Forecast for June: 79.6
Range: 76.0 to 88.8
The nation's Current Account Deficit totaled $224.9 billion in the fourth quarter, representing a steep 7.0% of GDP and well up from the low 6% levels of prior quarters.
Current Account Deficit Consensus Forecast for First Quarter: -$222.0 billion
Range: -$226.0 billion to -$185.4 billion
Is the Fed in a Modest Tightening Mood'
