To no one's surprise, the FOMC announced a 25 basis point rate hike in the federal funds target. This brought the funds rate to 1.75 percent, three-quarter's of a point higher than it was three months ago. The rate last stood at 1.75 percent between November 2001 and November 2002. The Fed's statement, which has lately gotten more attention than the rate movement, was just about unchanged from the August meeting. Based on the statement, it appears that Fed officials will probably continue to raise the funds rate target "at a measured pace" until they reach a neutral, or equilibrium rate. Many economists, including San Francisco Fed President Janet Yellen, believe the neutral rate is close to 3.5 to 4 percent.
Some economists are thinking the Fed will probably raise the funds target again at the November meeting but then take a pause. Indeed, former Fed Governor Larry Meyer has said the FOMC doesn't like to make rate changes in December because markets are less liquid.
If the Fed does raise rates in November, that would bring the fed funds rate target to 2 percent - roughly halfway to the equilibrium rate. In a robust economy, they would probably be able to raise rates quickly, but many economists have scaled back their forecasts for rate hikes in 2005 since growth is expected to be good but not exceptional. With eight scheduled meetings during the year, a 25 basis point hike at each one would bring the fed funds rate target to 4 percent. However, this is not the consensus forecast at this time.
Recap of US Markets
STOCKS
Stock prices declined this week, not so much because the Fed raised the funds target but because some companies are starting to issue warnings about third quarter earnings. Furthermore, crude oil prices shot up again this week after the Energy Information Agency (EIA) reported that inventories fell sharply in the week ended September 17 due to the effects of Hurricane Ivan.
BONDS
The shape of the yield curve has shifted slightly in the past four weeks. Shorter-term rates (3-month and 2-year) are higher today than they were a month ago, but intermediate and longer-term rates (5-year, 10-year and 30-year) are lower. It appears short-term rates are rising because the Fed has indeed increased the federal funds rate target to 1.75 percent. However, long-term rates may have declined recently because economic growth is not accelerating rapidly and inflationary pressures are not currently an issue.
Since mortgage rates move in tandem with the 10-year Treasury note, the lower 10-year yield will help keep mortgage rates down. However, home equity loans as well as most credit card loan rates are tied to the bank prime rate. The prime rate moves in tandem with the funds target and currently stands at 4.75 percent. This means that consumers' short-term debt will be financed by higher rates. If credit card balances become more onerous due to the higher rates, consumers will have less money to spend on goods and services. Similarly, higher home equity loan rates will increase consumer payments and limit discretionary spending.
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
Durable goods orders dip in August
New orders for durable goods orders fell 0.5 percent in August after posting relatively healthy gains of 1.3 percent in June and 1.8 percent in July. The drop was primarily a result of a plunge in aircraft orders. Excluding the volatile transportation sector, new orders jumped 2.3 percent in August, significantly better than the June and July showings.
Among the various industry sectors, fabricated metals, computers & electronics and electrical equipment posted healthy gains in new orders in August. However, nondefense capital goods orders, a leading indicator for capital spending, dropped 7.4 percent. This was largely due to the decline in aircraft orders. Nonetheless, new orders excluding aircraft were still down 0.5 percent during the month after gaining 0.6 percent in July and 1.8 percent in June. Unless we see an upward trend redevelop in September and October, the outlook for capital spending may be in doubt. Economists are counting on capital spending to spur economic growth since consumer spending has softened lately.
Mixed bag on housing in August
Housing starts inched up 0.6 percent in August to a 2.0 million-unit rate after jumping 9.4 percent in July to a 1.99 million-unit rate. Starts had dropped in April, May and June when mortgage rates were on the rise. Since mortgage rates have once again declined, housing starts have picked up a bit. The Census Bureau suggests it takes five months to establish a trend in the series since monthly fluctuations are large. Notice the five-month moving average reveals that total housing starts peaked in January 2004 and have since moderated a bit, but have nonetheless hit a fairly healthy plateau. In August, starts were 9 percent above year ago levels.
Starts of single-family homes inched up 0.4 percent in August to a 1.67 million-unit rate after a 9.2 percent hike in July. The trend for the single-family market is slightly different in that a new peak was reached in August using the Census Bureau's rule of looking at a 5-month moving average. Mortgage rates have dipped in the first part of September and this could spur activity further as the third quarter draws to a close.
Existing single-family home sales declined in August, in contrast to single-family housing starts. The 2.7 percent drop brought home resales to a 6.54 million-unit rate for the month. Sales had also declined in July. Home resales fell in all regions of the country but the Northeast, where they were unchanged. Despite the August decline, existing home sales are up 2.3 percent from year ago levels. All regions of the country, except for the Midwest, showed year-over-year gains for the month.
While mortgage rates have certainly fueled housing activity in the past year, many potential new homeowners are finding that the rapid run-up in home prices have simply priced them out of the market. Prices of starter homes in many regions of the country - primarily on the east and west costs - are higher than local median family incomes. Housing appreciation is well and good for current homeowners who benefit from the increased value of their homes. But it certainly makes it difficult for new consumers to enter the market if they don't have sufficient savings or built-in equity. Indeed, both the median sales price and the average sales price of existing homes decreased in July and August, suggesting that perhaps housing price hikes may stall for a while.
The Bottom Line
The FOMC announced another hike in the federal funds rate target indicating in their post-FOMC statement that the economy is regaining traction. Actually, many of the August indicators were weaker than those posted in June and July, although August employment was stronger (although still anemic for this stage of the business cycle).
Next week will bring a slew of data to monitor and closely analyze. Early in the week, economic indicator reports will be covering August data. On Friday, several key indicators, including the ISM manufacturing index and motor vehicle sales, will give us a peak at September data.
Looking Ahead: Week of Sept 27 to Sept Oct 1
Monday
New home sales dropped 6.4 percent in July to a 1,134,000-unit rate after declining 5.6 percent in June. Sales plunged 23.5 percent in the Northeast and 15.9 percent in the South! They decreased only 1.7 percent in the West but managed to post a whopping 21.5 percent hike in the Midwest.
New home sales Consensus Forecast for Aug 04: 1,115,000 unit rate
Range: 1,012,000 to 1,250,000-unit rate
Tuesday
The Conference Board's consumer confidence index dropped sharply in August to a level of 98.2 after reaching a level of 105.7 in July. Skyrocketing oil prices and soggy employment figures played a role in reducing optimism among consumers.
Consumer confidence Consensus Forecast for Sept 04: 100
Range: 94.5 to 102
Wednesday
The Commerce Department's preliminary estimate showed that real GDP grew at a 2.8 percent rate in the second quarter. The final estimate usually doesn't show much difference from the preliminary, but it depends largely on unknowns such as business inventories and international trade balances which become available much later than other components of GDP.
Real GDP Consensus Forecast for Q2 04: 3.0 percent annual rate
Range: 2.8 to 3.3 percent annual rate
GDP deflator Consensus Forecast for Q2 04: 3.2 percent annual rate
Range: 2.9 to 3.2 percent annual rate
Thursday
New jobless claims increased 14,000 in the week ended September 18 to 350,000 after rising 18,000 in the previous week. Consequently, the four-week moving average increased to 341,000. According to Labor Department officials, the latest week's rise was mostly hurricane related (Charley and Frances, but not yet Ivan).
Jobless Claims Consensus Forecast for 9/25/04: 340,000 (-10,000)
Range: 330,000 to 365,000
Personal income inched up a meager 0.1 percent in July and 0.2 percent in June after posting healthier gains in the first five months of the year. Healthier employment gains in August suggest improved income growth for the month. Personal consumption expenditures increased 0.8 percent in July - spurred by healthy auto sales. August auto sales dropped and this will put a damper on total consumer spending for the month.
Personal income Consensus Forecast for Aug 04: 0.4 percent
Range: 0.1 to 0.5 percent
Personal consumption expenditures Consensus Forecast for Aug 04: 0.1 percent
Range: 0.0 to 0.2 percent
The NAPM-Chicago dropped more than 7 points in August to 57.3 after recording a healthy spurt in July. This index has fluctuated sharply over the past six months suggesting that business activity has grown in fits and starts. This index is often considered a leading indicator of the ISM manufacturing index, but remember that it also includes non-manufacturing activity.
NAPM-Chicago Consensus Forecast for Sept 04: 58
Range: 54.5 to 60.7
Friday
The ISM manufacturing index fell 3 points in August to 59 percent. New orders and production both posted declines as did employment. Among index components, only inventories rose in August. The price index, which is not part of the manufacturing index, jumped more than 4 points during the month to 81.5, partly reflecting higher energy prices.
ISM manufacturing index Consensus Forecast for Sept 04: 58.3
Range: 55.4 to 61
Construction spending increased 0.4 percent in July after remaining unchanged in June. Residential construction expenditures have moderated their rate of growth and the nonresidential sector has not yet picked up steam.
Construction spending Consensus Forecast for Aug 04: 0.5 percent
Range: 0.0 to 0.6 percent
The University of Michigan's consumer sentiment index remained virtually unchanged at the mid-September reading at 95.8 from the August reading of 95.9. September stock prices were on the mend in the first half of the month while oil prices dropped.
Consumer sentiment index Consensus Forecast for Sept 04: 95.8
Range: 94 to 96.5
Domestic motor vehicle sales decreased 4.3 percent in August after a 15.7 percent spurt in July. Domestic auto sales fell to a 5.2 million-unit rate while light truck sales decreased to an 8.3 million-unit rate. Incentives tend to be healthy this time of year as dealers want to rid their lots of 2004 model cars.
Light truck sales Consensus Forecast for Sept 04: 8.1 million-unit rate
Range: 7.9 to 8.4 million-unit rate
Auto sales Consensus Forecast for Sept 04: 5.3 million-unit rate
Range: 4.9 to 5.3 million-unit rate
Another Fed rate hike
