BONDS
Once again, rates have declined across the board except for the 3-month bill which edged up a few basis points. Basically, bond investors still believe the Fed will raise the fed funds rate target at the November 10 meeting, (the week after the election), but investors are confused about the direction of the economy and global events. Consequently, the U.S. Treasury market is serving its role as a safe-haven port. With polls suggesting the candidates are neck and neck, market players are concerned there may be a repeat of 2000. As long as the election yields a true and apparent winner, market players may be relieved whether they are happy with the results or not - simply because it will be over.

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

September CPI increases moderately
The consumer price index increased 0.2 percent in September after remaining essentially unchanged over the July-August period. Energy prices fell for the third straight month, albeit by a small amount; food prices were unchanged. Excluding the volatile food and energy components, the core CPI increased 0.3 percent, significantly faster than the past three monthly gains of 0.1 percent. Nearly every major category of the CPI increased more rapidly in September than in July or August. Most of the time, when the core CPI accelerates, one can point to one or two major culprits. While the total CPI moderated its year-over-year gain to 2.5 percent in September, the core CPI accelerated its year-over-year gain to 2 percent. It doesn't seem like much for the past couple of months, but it is nearly twice as fast as the year-over-year gain of 1.1 percent recorded in January this year.

The rise in the CPI worried bond investors. Inflation-phobes are always concerned about accelerating inflation and many have worried that the accelerating rate of energy price hikes would eventually filter through the pipeline. The rising core portion of the CPI is one factor that may keep the Fed on track with respect to its rate hikes in coming months. San Francisco Fed President Janet Yellen, who in September sounded hawkish, suggested the Fed may need to "pause rate hikes if slower demand hurts GDP and the job market". Yellen also said current inflation fundamentals are lower than the data suggest. Nevertheless, she still believes the fed funds rate needs to get to a neutral level, which she defined as 2 - 3 percentage points over the inflation rate.

Housing starts decline in September
Housing starts fell 6 percent in September to a 1.898 million-unit rate, bringing the level of activity 1.2 percent below last year's pace. The Census Bureau believes it takes five months to establish a trend in the data. We've depicted the five-month average of total housing starts as well as single-family housing starts in the chart below. Despite the September decline in starts, the five-month average reveals that housing activity is still significantly stronger than this time last year. Similarly, single-family starts fell 8.2 percent in September, but the five-month average is still relatively stable.

The historically low level of mortgage rates has certainly spurred housing activity over the past 18 months. However, lack of improvement in the labor market may prevent potential new homeowners from entering the market. After all, low monthly payments mean little to people who don't have jobs and simply can't afford to even consider buying a house.

In the meantime, we may see some additional purchases of furniture, home furnishings and appliances to match up with the spurt in activity six months ago. For now housing starts have stabilized and increases in retail sales may be limited - unless we see a new spurt in housing activity.

Low mortgage rates will help those people who have not previously refinanced their home loans. However, the refinancing activity of the past two years was so dramatic that there have to be only a few procrastinators out there who have not already refinanced. Thus, we are not likely to see a consumer spending binge financed by lower monthly payments or equity cash outs.

Philly Fed survey improves in October
The general business conditions index from the Philadelphia Fed's business outlook survey more than doubled in October to 28.5 from a level of 13.4 in September. This brought the index level back to where it was in August. Historically, the Philadelphia Fed's index has done a good job of predicting the direction of change in the index of industrial production. The relationship appears to have deteriorated a bit in the past year, but on the whole, the trend pattern holds. The improvement in October in the Philly Fed survey suggests that we could see improved industrial production growth for the upcoming month.

The Bottom Line
The consumer price index accelerated somewhat in September causing market players to worry that higher energy prices have seeped into other components of the CPI. Fed official Janet Yellen is not concerned about long-term inflation fundamentals at this point, however.

Housing activity remains relatively stable even as mortgage rates have fallen again. Without improved labor market conditions, new homes may be out of reach for many potential buyers even with lower interest rates.

Economic news was somewhat sparse this week; market players will have more news to mull over in the upcoming week although they will be primarily concerned with election issues.

Looking Ahead: Week of Oct 25 to Oct 29

Monday
Existing home sales fell 2.7 percent in August to a 6.54 million-unit rate after declining in July as well. Mortgage rates have moderated in recent months and this could keep home sales healthy for a few more months.

Existing home sales Consensus Forecast for Sept 04: 6.55 million-unit rate
Range: 6.25 to 6.85 million-unit rate

Tuesday
The Conference Board's consumer confidence index decreased roughly two points in September to 96.8. In July, this index reached a high of 105.7. However, with rising oil prices and no real improvement in the labor market, consumer confidence is waning.

Consumer confidence index Consensus Forecast for Oct 04: 94
Range: 91 to 95

Wednesday
Durable goods orders edged down 0.3 percent in August, due entirely to a sharp drop in transportation equipment. Primary metals, fabricated metals, machinery, computers & electronics, and electrical equipment all posted healthy gains.

Durable goods orders Consensus Forecast for Sept 04: 0.5 percent
Range: -1.0 to +2.4 percent

New home sales jumped 9.4 percent to a 1,184,000-unit rate in August, spurred by declining mortgage rates. The drop in yields over the past three months, despite Fed hikes in the fed funds target, could help keep housing activity strong for a few more months.

New home sales Consensus Forecast for Sept 04: 1,150,000-unit rate
Range: 1,100,000 to 1,200,000-unit rate

The Fed's Beige Book should get plenty of attention by market players who will be looking for news on consumer spending, housing activity and particularly new employment prospects. The book will likely cover activity through October 15th or so.

Thursday
New jobless claims fell 25,000 in the week ended October 16 to 329,000, the lowest weekly level in six weeks. The 4-week moving average dipped to 348,250. The week did include a holiday and although the figures are adjusted for seasonal variation, holiday-shortened weeks are usually followed by weeks with increases in claims.

Jobless Claims Consensus Forecast for 10/23/04: 335,000 (6,000)
Range: 320,000 to 340,000

Friday
The Bureau of Economic Analysis is set to release its advance estimate for third quarter real GDP. Economists are estimating that growth will accelerate, although not be far off from the second quarter pace when real GDP increased at a 3.3 percent rate. The difference may lie in faster growth for real final sales and moderating growth for inventories.

Real GDP Consensus Forecast for Q3 04: 4.3 percent annual rate
Range: 3.1 to 5.0 percent annual rate

GDP deflator Consensus Forecast for Q3 04: 1.5 percent annual rate
Range: 1.0 to 2.2 percent annual rate

The employment cost index increased 0.9 percent in the second quarter with a moderate gain in wages but a spurt in benefit costs. Third quarter gains may follow a similar pattern as costs of benefits continue to rise more rapidly than wages.

Employment cost index Consensus Forecast for Q3 04: 1.0 percent
Range: 0.9 to 1.4 percent

The NAPM-Chicago jumped 4 points to 61.3 in September after a sharp August drop. The NAPM-Chicago is considered a leading indicator for the ISM manufacturing index. Keep in mind, however, that it covers (non-manufacturing) business activity as well.

NAPM-Chicago Consensus Forecast for Oct 04: 59
Range: 56.5 to 60.5

The University of Michigan's consumer sentiment index decreased nearly 7 points at the mid-month reading from the September level. Rising oil prices and little job growth don't allow for healthy gains in consumer optimism.