The week's rally helped boost prices well above year-end levels - except for the Dow which is still under water by 0.6 percent. The Russell 2000 has regained most of its summer losses and is now up 8.5 percent from year-end.

BONDS
The bulk of the movement in the bond market took place after Friday's employment report showed not only a 337,000 increase in October payrolls but a cumulative gain of 113,000 for the two previous months as well. As a result of the one-two punch, bond investors now believe the Fed will, without a doubt, raise its fed funds rate target by 25 basis points this coming Wednesday to 2 percent and will probably raise rates again at their December meeting. Furthermore, the Fed is likely to raise rates in February at the first FOMC meeting of 2005, or such is the belief in the bond market.

Bond investors are forgetting the Fed will have the luxury of viewing the November employment report before making any decision at their December meeting and the January report before their February meeting. Perhaps the October employment report was fluke, a one-time event' Also, the Fed may choose to pause in December because markets are notoriously thin that time of year.

Bond investors may also come to the realization that the Bush administration will be supplying a lot of Treasury securities in upcoming months to pay for the budget deficit. Eventually, the increased supply of Treasury securities will likely make them more costly.

Bond yields may also begin to rise in reaction to Fed rate hikes. In 2004, yields fell despite rate hikes as safe-haven demand flooded the market. Now that the election is over, and we did not have a repeat of 2000, the imbedded premium against risk can be removed from the market.

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

Nonfarm payrolls jump
Nonfarm payroll employment jumped 337,000 in October after recording upward revised gains of 139,000 in September and 198,000 in August. This represents a cumulative revised gain of 113,000 for the prior months. Furthermore, this puts the 3-month moving average at 225,000 through October. This is healthy expansion given that conventional wisdom pegs payroll gains at 150,000 just to keep up with population growth.

The Labor Department says it really doesn't know how much of the growth in nonfarm payrolls is related to rebuilding and clean up after the record hurricane season. But many economists are saying the 71,000 spurt in construction jobs during September is hurricane-related. In the previous four months, construction payroll gains did average 9,000 per month, a modest rate but still pointing to sources other than hurricanes. But even if one were to believe that the entire construction gain was due to hurricane rebuilding, nonfarm payrolls growth would still be decent, at 266,000 (337,000 less 71,000). Also, there is no question that the upward revisions to August and September payrolls make the entire three-month period (August - October) much better than originally thought.

Keep in mind, however, that despite three months of improvement, gains are not exceptional as the employment recovery over the past three years is still meager by historical standards.

The civilian unemployment rate edged up to 5.5 percent in October after dipping to 5.4 percent in August and September. The increase in the rate was due to a spurt in labor force growth that was not quite matched by an equal gain in employment (although household employment did post a respectable rise of 298,000 in October). The October uptick in the unemployment rate is not statistically significant. And, in fact, it is almost encouraging to see the rise stemming from labor force growth. If workers believe that jobs are easier to find, more will re-enter the labor force and start looking for work. We consider the employment-to-population ratio a more reliable measure of employment conditions, and it was unchanged in October from the September pace. It remains anemic by historical standards. Even three years ago, when the jobless rate also stood at 5.5 percent, the employment-to-population ratio was significantly higher.

Total weekly hours in the private sector remained unchanged at 33.8 for the third time in four months. However, the factory workweek dipped 6 minutes to 40.7 hours. Coupled with a slight 5,000 dip in factory payrolls, this suggests that industrial production is not likely to show much growth in October.

All in all, the October employment report does show an improved picture of the labor market over the previous three months. Financial market players are now no longer thinking the Fed will pause after they likely raise the fed funds rate target next week. Bond market players are now looking for a rate hike in December and another one in February. This is the standard reaction one would expect from a reactionary market. It is certainly possible the Fed will not pause and continue to raise rates by 25 basis points increments after the November meeting. However, the Fed doesn't like to increase rates in December because markets tend to be less liquid as many traders have closed their books and many investors are on vacation. If the Fed were to omit a rate hike in December, it would not necessarily signal a "pause" but a decision to "remove policy accommodation at a measured pace." They could very well continue to raise rates at the first FOMC meeting of 2005 (see bond market section above).

Productivity moderates
Nonfarm productivity rose at a moderate 1.9 percent rate in the third quarter after increasing at a 3.9 percent rate in the second quarter. The third quarter pace was the slowest since the fourth quarter of 2002. GDP growth increased just a bit faster than in the previous quarter but employment growth was stronger in the third quarter than in the second quarter, and this dampened productivity growth.

As a consequence, unit labor costs accelerated in the third quarter to a 1.6 percent rate from a 1 percent rate in the second quarter. Whenever productivity growth moderates, unit labor costs increase more rapidly. However, notice that over the past three years, overall gains in unit labor costs have been meager. This helps companies keep their compensation costs down.

ISM surveys diverge
On Friday of the prior week the NAPM-Chicago index surged (tan bar), but in contrast to market expectations the ISM surveys didn't show the same exuberance. In fact, the ISM manufacturing index fell back to 56.8 in October, posting a third straight monthly drop. The ISM non-manufacturing index did manage to jump about three points to 59.8 in October after declining in the two previous months. In all cases, the surveys are well above the 50 percent mark and this reflects expansion. But at least the ISM manufacturing survey suggests slightly more moderate activity in October. Indeed, the drop in factory payrolls coupled with a slight dip in the factory workweek does not point to a strong industrial production index for October.

Q3 factory orders rise
Factory orders dipped 0.4 percent in September despite a 0.2 percent rise in durable goods. Nondurable goods orders dropped 1 percent during the month, hampering total new orders. Still the quarterly picture is pretty good with total new orders rising at a 9.2 percent rate in the third quarter, just a bit more slowly than in the second quarter. Nondefense capital goods orders grew at a healthy 21.6 percent rate, accelerating from the pace of the past several quarters. New orders for information technology equipment grew at an 11.8 percent rate, a significant improvement from the previous quarter.

Motor vehicle sales drop in October
Motor vehicle sales of domestically produced cars and light trucks fell 7 percent in October to a 13.2 million-unit rate from September's selling pace of 14.2 million units. Car sales fell less dramatically from a 5.3 million-unit rate to a 5.1 million-unit rate in October. Light truck sales declined from an 8.9 million-unit rate to an 8.1 million-unit rate. The sharp fall-off in SUVs had to be affected by surging gasoline prices.

Notice in the graph below that new truck purchases as a percentage of motor vehicles declines whenever a new spurt in gasoline prices takes place during the month. For instance, rising gasoline prices in the spring and summer led to a smaller percentage of new truck purchases during those months. The same effect is evident in October as light truck sales accounted for 61.7 percent of new purchases, a drop of 1.3 percentage points from September as gasoline prices jumped 7.2 percent during the month.

The Bottom Line
The markets have had a hectic spell: a presidential election and employment all in the same week! Market players were surely relieved that the election, though close, produced a clear winner. The country did not have to replay the 2000 experience again. While Bush devotees suggest the stock market rallied on Wednesday and Thursday because a Bush administration will be pro-business, they are probably ignoring the risk premium built into the market for election disaster and gridlock. Perhaps Bush is viewed as pro-business today because of his inclination to reduce taxes. However, market players may change their tune if soaring budget deficits cause interest rates to rise sharply - and that would eventually choke off investment and consumer spending.

More excitement ensued on Friday when nonfarm payrolls actually turned out to be stronger than expected - and were accompanied by upward revisions to the two previous months. This caused bond and equity investors to reassess their thinking on Fed policy. Market players are now thinking the Fed will not "pause" after all after raising the fed funds rate target next week. Keep in mind that the October employment report could have been a fluke (although we certainly are due some good news on the labor market front), and Fed officials will have the benefit of another employment report before the December FOMC meeting.

Looking Ahead: Week of Nov 8 to Nov 12

Wednesday
New jobless claims fell 19,000 in the week ended October 30 to 332,000, after rising 21,000 in the previous week. The 4-week moving average inched down to 342,000. According to the Labor Department, declines in claims in Florida accounted for a part of the drop.

Jobless Claims Consensus Forecast for 11/6/04: 340,000 (+8,000)
Range: 328,000 to 340,000

The international trade deficit on goods and services widened sharply in August to $54 billion after narrowing momentarily in July. Exports inched up in August, but imports surged - spurred in part by gains in energy prices. Oil imports (as well as higher prices for oil) could remain a factor in holding up imports.

International trade balance Consensus Forecast for Sept 04: $-53.5 billion
Range: $-55 to $-51

Import prices inched up 0.2 percent in September after posting a sharp 1.4 percent hike in August. Higher oil import prices are likely in coming months and this will boost import prices. Excluding petroleum, import price hikes have been moderate.

Import prices Consensus Forecast for Oct 04: 1 percent
Range: 0.6 to 1.5 percent

Export prices Consensus Forecast for Oct 04: NA
Range: NA

Market players expect the Fed to raise the federal funds rate target by 25 basis points at their meeting today, bringing the level up to 2 percent. Today's FOMC meeting may not be the last one of the year with a rate hike announcement. Many market players now believe the Fed could raise rates at their December meeting too.

Fed funds rate target Consensus Forecast for Nov 10 04: 2.0 percent (+0.25 basis points)
Range: NA

The U.S. Treasury is scheduled to report its budget balance for the first month of fiscal year 2005. Typically, October figures are usually in deficit and averaged $33.1 billion over the past 10 years. Deficit figures were higher than this average in FY03 and FY04.

Federal budget Consensus Forecast for Oct 04: $-58 billion
Range: $-60 to $-49 billion

Friday
Retail sales jumped 1.5 percent in September after inching down 0.2 percent in August. A 4.2 percent hike at motor vehicle dealers spurred sales. Excluding autos, sales rose 0.6 percent in September. October sales may not be so robust; domestic auto sales as well as light truck sales fell sharply during the month.

Retail sales Consensus Forecast for Oct 04: 0.1 percent
Range: -0.2 to +0.7 percent

Sale ex autos Consensus Forecast for Oct 04: 0.5 percent
Range: 0.3 to 0.7 percent

Business inventories rose 0.7 percent in August after a 1 percent hike in July. Gains are expected to be more moderate in September. We already know that manufacturers' inventories moderated significantly during the month. Inventory figures may affect estimates for 3rd quarter GDP revisions.

Business inventories Consensus Forecast for Oct 04: 0.5 percent
Range: 0.3 to 0.7 percent

Consumer sentiment fell more than 2 points in October to 91.7. The index now stands five points below the high recorded in July. Consumers may be relieved that the elections are over, but the job market is not on fire and gasoline prices are still high and rising.