The FOMC met on May 10 and voted unanimously to raise the federal funds rate target by 25 basis points to 5 percent. This brought the target rate to its highest level since early 2001. The rate hike was anticipated, and market players were more interested in dissecting the post-meeting statement. After careful scrutiny by Wall Street economists and Fed watchers across the globe, it was determined that the Fed - could raise rates again at the June meeting, or might pause in June in order to wait and see what the data was telling them. So, in reality, Fed watchers have no greater clue today about future Fed rate hikes than they did before the meeting.
Let's get one thing straight though. Until now, the Fed has been concerned about getting the fed funds rate target to neutral. Neither Greenspan nor Bernanke has indicated their numeric target for neutral. However, several well-respected district bank presidents such as Janet Yellen from San Francisco and Cathy Minnehan from Boston have indicated that the neutral rate would be in the 3.5 to 5.5 percent zone. That gives us a mid-point of 4.5 percent. The rate hikes have surpassed that level. It is most likely that the Fed is no longer aiming for a neutral zone. Instead, Fed officials are trying to tighten, or to use the current Fed phrase, to firm, credit conditions given concerns that inflationary pressures will percolate due to rapidly accelerating energy and commodity prices.
Bernanke & Company didn't give market players a clue about their June intentions because they probably don't know how the economy will exactly shape up between now and then. They have the luxury of determining their policy at the meeting and don't need to forecast it. Consequently, their statement appears ambiguous because they are giving themselves the flexibility to determine policy as they see fit.
Economists are on both sides of the fence on this one - with some believing the Fed will raise rates one or two more times (in June and August) and some believing they will pause and then raise rates in August or September when economic conditions force their hand. The majority of economists do not believe that 5 percent will be the peak rate for this cycle.
Recap of US Markets
STOCKS
Sometimes it seems difficult to please market players. If the Fed doesn't raise rates, perhaps they are being soft on inflation, and if they do raise rates, they might be too tough on the economy. And if the Fed isn't quite certain about its future policy actions - well, uncertainty is worst of all! Market players were not too thrilled with the post-meeting FOMC statement. Moreover, investors were worried about rising crude oil and other commodity prices. Gold continues to surge - making a succession of 25-year highs. Add geopolitical concerns to the mix, and the result is the chart below: declining stock prices.
The uncertainty of future Fed policy and the current environment appears to be causing greater worries in the high tech and small cap sectors: the Nasdaq composite and the Russell 2000. Declines in the Dow and the S&P 500 were smaller than for the other two indexes this week. Year-to-date, the small cap market, measured by the Russell 2000, continues to outperform the large cap sector with a 10.3 percent gain - but this sector has lost a lot of ground in the past month. The Dow Jones Industrials are up 6.2 percent from year-end, and the Wilshire 5000 is 4.5 percent higher. The other blue chip index, the S&P 500, is showing a smaller year-to-date gain of 3.4 percent. The Nasdaq composite index is up the least since year-end: 1.7 percent.
BONDS
The intermediate segment of this yield curve is still a little flat, but for the most part, the yield curve is positively sloped with yields on longer-term maturities higher than yields on shorter-term maturities. The inverted yield curve is gone for now.
In the old days when market players reacted to what were sudden, unannounced rate hikes, higher rates after a 25-basis-point rate hike would not be considered unusual. But since the Fed began to follow a more transparent policy, the Treasury yield curve hasn't reacted as much. Some analysts are suggesting that the long end of the yield curve has picked up recently because investors might be worried about inflationary pressures. That is, investors might be worried that the Fed is not firming policy enough. We'll just have to wait and see.
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 MODERATE
Total retail sales increased 0.5 percent in April, nearly the same as March's 0.6 percent hike. Excluding the volatile auto component, retail sales inched up 0.7 percent in April after gaining 0.5 percent in March. However, a bulk of the April hike came from surging energy prices as sales at gas stations jumped 4.6 percent in April after remaining unchanged in March. Retail sales excluding autos and gas stations inched up only 0.2 percent in April after gaining 0.6 percent in March. Considering the January sales spurt, one might be inclined to chalk it up to monthly fluctuations and simply state that the fourth month average is still pretty healthy.
Keep in mind though, that we (economists) said that December sales were probably softened by consumers buying gift cards - which were then redeemed in January. Due to seasonal adjustment procedures, the January sales simply ballooned out of proportion. Or something like that. The chart below depicts actual monthly changes in retail sales excluding autos & gas, along with a 3-month moving average and a 6-month moving average. The moving average gives some indication of momentum. The hefty January gain falls out of the 3-month moving average with the most recent month's data and it appears that retail sales growth plunges by April. The 6-month average includes the January spike, but notice that the trend is still much lower than it was in the two previous months. But at 0.6 percent in April, the 6-month moving average is roughly on par with the 6-month average seen prior to the outsized January gain. So after all is said and done, the trend analysis suggests that retail sales are roughly in line with 2005 sales.
But there is a catch. Market players don't tend to always analyze these types of trends - and the standard operating procedure in economic forecasting is to look at quarterly growth rates such as GDP growth in Q1, Q2, etc. The sluggish path in April won't exactly boost consumer spending in the second quarter. And while the analysis suggests that retail sales are really not as weak as they looked in April, it doesn't tell us whether or not the April numbers will be repeated or whether consumers really will spend less money on discretionary items since they have to spend so much more on gasoline.
Regular readers of this weekly column know that I am not a big fan of consumer attitude surveys as predictors of monthly retail sales. However, the University of Michigan's consumer sentiment index plunged to 79 in mid-May reflecting consumers' distaste for accelerating gasoline prices. The last time this index fell so much was right around hurricane season when gasoline prices were also over $3/gallon. We have all seen the man/woman at the pump interviews. Most people are not changing their driving habits. One cannot dip into savings forever to finance spending on discretionary items. Sooner or later, retail sales will have to be scaled back if consumers spend more at the pump. So perhaps, April nonauto, nongas retail sales growth could be indicative of the current environment and this behavior could be repeated in upcoming months.
MARCH TRADE DEFICIT MODERATES
The international trade deficit on goods and services moderated to $62 billion in March after recording a $65.6 billion shortfall in February. It appears that the narrowing of the trade deficit was an aberration from the trend due to an anomaly in crude oil price accounting. Apparently, the price of crude oil (as measured in these data) fell in March and this dampened the import bill. No one expects demand for crude to drop in coming months and we already know that the April average price of crude is higher than the March average. The lower-than-expected deficit for March will help to boost first quarter GDP estimates from the current 4.8 percent growth rate. But don't expect further narrowing of the trade deficit in coming months.
APRIL IMPORT PRICES JUMP
Import prices jumped 2.1 percent in April, due primarily to an 11.5 percent spurt in petroleum import prices. Nonfuel import prices inched up 0.1 percent. On a year-over-year basis, import prices were up 5.9 percent in April, but petroleum import prices were 32.5 percent higher than a year earlier. While the import price index is not adjusted for seasonal variation, price changes in the petroleum import price index often move in tandem with the energy price component of the producer price index. In the two previous months, changes in petroleum import prices were small and these were not entirely reflected in the energy PPI. However, there is no question that April's spike will in some form translate into higher energy prices in the April PPI.
The Bottom Line
Economic indicators were relatively sparse this week, but market players would have focused on the Fed in any case. The announcement of the 16th rate hike, bringing the federal funds rate target to 5 percent, was widely anticipated. Market players are trying to figure out what the Fed will do next. Will they raise rates in June' Or will they pause' The Fed's post-meeting statement was ambiguous, because Fed officials want to see May and June data before deciding whether or not to raise the funds rate target to 5.25 percent in June - or at a later date.
The upcoming week will see a slew of key data - including inflation and production numbers.
Looking Ahead: Week of May 15 to May 19
Monday
The Empire State manufacturing index decreased 13.2 points in April to 15.8. This was the lowest level in the business conditions index since October 2005. Any level above zero points to an expanding manufacturing sector in this Fed district.
Empire State index Consensus Forecast for May 06: 17
Range: 9.7 to 20
Tuesday
The producer price index increased 0.5 percent in March with energy prices rising 1.8 percent and food prices increasing 0.5 percent during the month. Excluding energy and food, the PPI rose 0.1 in March. The spike in the import price index suggests a spurt in energy prices in the April PPI.
PPI Consensus Forecast for Apr 06: 0.8 percent
Range: 0.5 to 1.2 percent
PPI ex food & energy Consensus Forecast for Apr 06: 0.2 percent
Range: 0.1 to 0.4 percent
Housing starts declined 7.8 percent in March to a 1.96 million-unit rate with a plunge in single-family construction and a partial rebound in the multi-family sector. A March drop in housing starts was not unexpected. The more interesting question is what happens in the spring and summer'
Housing starts Consensus Forecast for Apr 06: 1.95 million-unit rate
Range: 1.875 to 2.10 million-unit rate
The index of industrial production increased 0.6 percent in March with healthy gains in high tech industries as well as motor vehicles and parts. Factory payrolls were up in April, although the workweek was unchanged. This could mean another moderate gain in production for the month.
Industrial production Consensus Forecast for Apr 06: 0.5 percent
Range: 0.2 to 0.6 percent
Capacity utilization rate Consensus Forecast for Apr 06: 81.6 percent
Range: 81.3 to 81.7 percent
Wednesday
The consumer price index increased 0.4 percent in March boosted by a 1.3 percent hike in energy prices. Excluding food and energy, the CPI rose 0.3 percent for the month, with higher prices in apparel and recreation. Crude oil prices were up in April and the EIA has been reporting higher average gasoline pump prices over the course of the month.
CPI Consensus Forecast for Apr 06: 0.6 percent
Range: 0.5 to 0.7 percent
CPI ex food & energy Consensus Forecast for Apr 06: 0.2 percent
Range: 0.2 to 0.3 percent
Thursday
New jobless claims dipped 1,000 in the week ended May 6 to 324,000, and the 4-week moving average increased to 317,250. Thus far, the level of claims in the first week of May is above the April average. April claims in turn were higher than in March, and this could mean that labor market conditions are softening a bit.
Jobless Claims Consensus Forecast for 5/13/06: 310,000
Range: 300,000 to 340,000
A few components of the index of leading indicators were positive in March: stock prices, vendor performance, and the interest rate spread. New jobless claims were higher during the month and this counts as a negative factor. The factory workweek was unchanged for the month; building permits and consumer expectations were down. Information is still not available on new orders for consumer goods and capital goods.
Leading indicators Consensus Forecast for Apr 06: 0.2 percent
Range: 0.1 to 0.3 percent
The general business conditions component of the Philadelphia Fed's business outlook survey inched up to 13.2 in April from a level of 12.3 in March. While overall levels are somewhat lower than the Empire State manufacturing survey, any level above zero indicates growth in manufacturing activity.
Philadelphia Fed survey Consensus Forecast for May 06: 14
Range: 11 to 20
Rate Hike Number 16
