Fed Chairman Alan Greenspan testified before the House Budget Committee this past Wednesday and, as he does often, left a mixed impression among financial market players as to what he thinks about the economy and what he plans to do at the upcoming FOMC meeting. The Fed chairman did say that rising oil prices will probably dampen economic activity in the second half, but he is no longer using the word "soft patch" to describe current conditions. Indeed, he said, "The expansion has regained traction." Oddly enough, some market players seem to believe the testimony indicates the Fed will not be aggressive in raising rates. Actually, it seems to us Greenspan was relatively upbeat about economic conditions - save for the dampening effect of oil prices.
On Thursday, San Francisco Fed President Janet Yellen was more forthcoming than the Fed chairman. According to Yellen, Fed policy remains overly accommodative and the fed funds rate target needs to head towards equilibrium - which she suggested was in the range of 3.5 to 4.5 percent.
According to Laurence Meyer's book, A Term at the Fed, the Fed chairman never sanctions speeches by various Fed officials; they each speak on their own views as they wish. Yellen's comments were not intended to confirm or deny Greenspan's remarks the day before.
Recap of US Markets
STOCKS
The stock market began the week on a strong note but then slipped on Wednesday, in part on Greenspan's remarks but mainly on negative earnings news. On the whole the market reacted to oil, rising when oil prices dipped and vice versa. Hurricanes Charley and Frances were bad news for Florida and now Ivan is approaching. Gulf oil platforms may be at risk. By the end of the week, prices were on the rise again, and the Friday close saw a gain over the previous week.
Alleluia! Several market indexes actually surpassed 100 - which means that at least the S&P 500 and the Russell 2000 are now higher than they were at year-end. (The Wilshire 5000 is also up from year-end, but it is not depicted on this chart.) The Dow Jones Industrials are still 1.3 percent below year-end levels and the Nasdaq composite index is under by 5.4 percent.
BONDS
The bond market faced 5-year note and 10-year note Treasury auctions this week; the results were not considered all that great as demand for the 10-year in particular was down relative to last month's auction. Despite the poor auction results, though, Treasury yields were generally lower this week as bond investors were more inclined to take this week's set of news as friendly. Each day, Treasury yields only fell by small increments, but by the end of the week, yields were down between 7 and 9 basis points.
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
Inflation: not today's problem
The producer price index dipped 0.1 percent in August, reversing the previous month's gain. Excluding the volatile food and energy components, the PPI also fell 0.1 percent. The declines were unexpected by economists and financial market players. They reflect a mere 0.2 percent gain in energy prices, which had risen 2.3 percent in July, and declines in a variety of components including cars (-1.2 percent) and light trucks (-2.5 percent) as well as computers (-1.7 percent) and food prices (-0.2 percent). Consequently, the PPI now stands 3.4 percent above year ago levels, and the core PPI is 1.5 percent higher than a year ago; both are an improvement over the past few months.
Market players and economists like to look at the producer price indexes at earlier stages of processing to see whether or not inflationary pressures are in the pipeline. In fact, the intermediate goods index rose 1 percent (with or without the food & energy components). Total intermediate goods prices are up 8.1 percent from a year ago, while the index excluding food & energy prices is 7.1 percent higher than last August.
Crude materials prices fell 0.7 percent in August after posting a 0.2 percent dip in July. For three straight months, food prices have fallen sharply and dampened the index. Excluding food and energy prices, the crude goods index rose 4.5 percent in August after an 8.6 percent hike in July! On a year-over-year basis, crude materials are up 22.4 percent while the nonfood, nonenergy index is up a whopping 32.3 percent from last August.
It isn't unusual to see much larger gains - or declines - in the crude goods index than the intermediate of finished goods indexes. Sometimes, increases at the crude materials stage are passed along the pipeline and intermediate goods prices accelerate - and then these are passed along to finished goods. However, not all price changes are passed along - depending on the economic environment. Right now, inflation has remained subdued for a long time and manufacturers have faced competitive pressures from imported goods. But manufacturers can't reduce profit margins forever - they'll go out of business. Most likely, some price hikes at the crude and intermediate levels will get passed along to the finished goods level, but not all.
Speaking of imports, the import price index jumped 1.7 percent in August after inching up 0.3 percent in July and now stands 7.2 percent above year ago levels. Petroleum import prices surged in August - up 9.6 percent. Non-petroleum prices rose 0.4 percent in the month after posting smaller gains in the three previous months. Increasing import prices - particularly for non-oil goods - allow domestic producers to also raise prices.
Trade deficit narrows
The international trade deficit on goods and services narrowed significantly in July to $50.1 after recording a $55 billion shortfall in June. As expected, the deficit was higher in July than in any other month except June since exports grew less in July than they decreased in June (+3.0 vs. -3.9 percent) and imports fell less in July than they rose in June (-1.4 percent vs. 2.9 percent). On the export side, both autos and non-auto capital goods posted healthy gains in July, helped a bit by exports of civilian aircraft. On the import side, crude oil and petroleum imports fell, as did non-auto consumer goods and non-auto capital goods. Auto imports rose for the month. Whether the value of the dollar is strong or weak, U.S. consumers love their imports.
Job market stalled
Weekly jobless claims fell in the week ended September 4, but weekly fluctuations in new claims are often due to special factors. The chart below depicts two layoff measures, new jobless claims and the Challenger job-cut series. Both are featured as a 3-month moving average to obscure spurious fluctuations. Between April and August, the averages look fairly stable. This means we haven't seen any real improvement in the labor market over the past several months. It's no wonder the various consumer attitude surveys are showing declines rather than increases. Even if the economy has regained traction, consumers won't see any benefit until layoffs begin declining and employment increasing.
The Bottom Line
Fed Chairman Alan Greenspan believes the soft patch in the economy has ended and the outlook is more optimistic for the upcoming months - aside from the fact that higher oil prices are likely to dampen economic activity. Indeed, most economists have lowered their forecasts for second half 2004.
In the meantime, inflation is not a real problem - the PPI for finished goods remained subdued. However, import prices jumped because of oil price hikes. Consumers will be feeling the negative impact of higher gasoline prices - and fuel oil prices too as temperatures drop.
The international trade deficit narrowed in July, as expected, but remains at stratospheric levels. Most economists are now claiming the only way to reduce the deficit is to see much sharper declines in the foreign exchange value of the dollar. In fact, importers need to pass along price increases or the dollar value can't impact decisions. But importers often prefer eating the difference to maintain their market share.
Several key economic indicators will be reported in the upcoming week. Market players are likely to focus on retail sales, industrial production and the consumer price index. Of course, that doesn't mean that they won't be diverted by such reports as the empire state manufacturing survey or consumer sentiment.
Looking Ahead: Week of Sept 13 to Sept 17
Monday
The U.S. Treasury's budget deficit amounted to $61.2 billion in July when the average deficit for the month was $22 billion over the past ten years. The August average over the past ten years is roughly $37 billion, but don't be surprised if the actual comes in much larger!
Treasury budget Consensus Forecast for Aug 04: $-40 billion
Range: $-38.5 to $-55 billion
Tuesday
Retail sales rose 0.7 percent in July, reversing the June drop of 0.5 percent. Excluding autos, sales rose 0.2 percent in July, not very different from June's 0.3 percent hike. Auto sales fell in August and this should dampen total retail sales. Also, Hurricane Charley may have had an impact on retail spending - although sometimes the effects are too small to notice on a macro scale.
Retail sales Consensus Forecast for Aug 04: -0.1 percent
Range: -0.5 to 0.3 percent
Retail sales ex autos Consensus Forecast for Aug 04: 0.2 percent
Range: -0.2 to +0.6 percent
The current account deficit, which measures trade in goods & services as well as income and investments, widened sharply in the first quarter to $144.9 billion. The spurt in the merchandise trade deficit in June suggests more deficit widening in the second quarter.
Current account Consensus Forecast for Q2 04: $-158.6 billion
Range: $-147.5 to $-165 billion
Wednesday
Business inventories rose 1 percent in June, accelerating their pace from previous months. Thus far, manufacturers' inventories are up 0.8 percent in July and wholesale trade inventories up a sharp 1.3 percent. Only retail inventories remain a question mark.
Business inventories Consensus Forecast for Aug 04: 0.8 percent
Range: 0.2 to 1.1 percent
The New York state empire manufacturing survey dropped off sharply in August from a robust July level. In any case, the level was still above the zero mark and that means manufacturing activity was still expanding.
Empire state manufacturing index Consensus Forecast for Sept 04: 18
Range: 8 to 23
The index of industrial production rose 0.4 percent in July, more than reversing the June drop of 0.5 percent. Manufacturing production posted a healthy 0.5 percent gain and even mining production rose 1.2 percent. However, utilities production decreased 2.1 percent, the second straight monthly drop.
Industrial production Consensus Forecast for Aug 04: 0.4 percent
Range: 0.1 to 0.7 percent
Capacity utilization rate Consensus Forecast for Aug 04: 77.4 percent
Range: 77.1 to 77.7 percent
Thursday
New jobless claims plunged 44,000 in the week ended September 4 to 319,000. This brought the moving average down to 339,250. According to Labor Department officials, this was due to seasonal adjustment issues; the entire drop was not due to an improvement in the labor market.
Jobless Claims Consensus Forecast for 9/11/04: 340,000 (21,000)
Range: 324,000 to 360,000
The consumer price index edged down 0.1 percent in July after rising 0.3 percent in June. Excluding food and energy prices, the CPI rose 0.1 percent in both June and July. Gasoline prices didn't rise much in August despite the spurt in crude oil prices and this could hold down the overall index.
CPI Consensus Forecast for Aug 04: 0.2 percent
Range: 0.1 to 0.2 percent
CPI ex food & energy Consensus Forecast for Aug 04: 0.2 percent
Range: 0.1 to 0.2 percent
The Philadelphia Fed's business outlook survey declined moderately in August, but to a much lesser extent than its New York cousin. Activity in the region was still pretty healthy last month. Despite the fact the Empire State index and Philadelphia survey don't move in tandem every month, market players still use the New York index as a leading indicator for the Philly index.
Philadelphia Fed index Consensus Forecast for Sept 04: 24
Range: 20 to 31
Friday
The University of Michigan's consumer sentiment index fell back to 95.9 in August from 96.7 in July. No doubt, rising oil prices and falling stock prices hurt consumer optimism.
Consumer sentiment index Consensus Forecast for mid-Sept 04: 97
Range: 93 to 98.5
"The expansion has regained traction," says Greenspan
