BONDS
Yields fluctuated during the week as bond investors tried to figure out what the Fed would do and say next week. At times, bond investors speculated that the Fed would become more aggressive this year, and at other times, they figured that the market factored in too many rate hikes too soon. By week's end, yields had dipped a bit from the previous week's close. While it appears that bond investors have already factored in a 25 basis points rate hike on Wednesday, one can never be sure how the market will react after the FOMC announcement at about 2:15 PM ET on Wednesday, June 30. After all, it will also depend on the post-FOMC statement, which could calm -- or roil the markets!

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

Home sales soar
Total single-family home sales rose 4.4 percent in May, the fourth straight monthly gain, which brought sales to a new peak. Existing single-family home sales, accounting for 83 percent of the market, increased 2.6 percent during the month. In contrast, new single-family home sales (the remaining 17 percent of this market) jumped 14.8 percent in May. Notice the two-month spurt in mortgage rates: the 30-year rate rose 38 basis points in April and 44 basis points in May. In the first few weeks of June, rates were slightly higher than May's 6.27 percent average. It isn't unusual to see home sales accelerate even as mortgage rates are rising. New buyers may be entering the market now in fear that rates will rise even more down the road. Moreover, employment conditions have improved in the past several months; more buyers may be eligible to become homeowners.

Furniture and appliance sales have not kept pace with home sales. The chart below compares the level of home sales to furniture & appliance sales, indexed to the first quarter of 1997. At times, furniture sales rose more rapidly than home sales and sometimes lagged. We've been in a lagging period for the past year and this could point to increased sales in furniture and appliances in coming months.

Durable goods orders drop
New orders for durable goods declined 1.6 percent in May after a 2.6 percent drop in April. The declines in the two months were not large enough to wipe out March's 5.9 percent spurt, but the two-month drop was disconcerting in light of the consensus forecast that called for a rise instead. Boeing had announced several aircraft orders for the month, and these usually tend to lift durable goods orders. However, most of the major components in durable goods posted declines: fabricated metals (-2.4 percent); machinery (-0.6 percent); computers & electronics (-1.8 percent); electrical equipment (-3.7 percent); and transportation equipment (-4.1 percent). New orders for primary metals managed to post a gain during the month (+3.6 percent).

In the first five months of this year, new orders were averaging monthly gains of 0.6 percent; less than the 2003 average of 0.9 percent. However, in the first five months of 2003, monthly gains averaged only 0.2 percent as the bulk of the positive news came later in the year. Fed surveys as well as the ISM manufacturing index for May were pretty healthy, perhaps suggesting that the May drop in factory orders was an anomaly. We will need more than two months of declines to confirm a new trend; after all, durable goods orders are notoriously volatile!

Commerce revises down Q1 GDP
Real GDP grew at a 3.9 percent rate in the first quarter of 2004, just a tad less than the fourth quarter pace of 4.1 percent. On its own, it would have been a fine number, but this was a 0.5 percent downward revision from the previous estimate reported a month ago. On the whole, consumption expenditures, investment and government spending all saw minor revisions. However, inventories were revised down slightly from the previous estimate while net exports were revised to show a significantly larger trade gap. Indeed, the trade deficit was $21 billion larger by the time the Commerce Department reported the final GDP figures relative to the advance report of two months ago. None of the other components showed as much change. The next largest revision came from business inventories, which were $10 billion higher in the latest report from the initial estimate of two months ago. Historically, net exports and inventories do show the largest revisions amongst the various GDP estimates since those are the two components for which the Bureau of Economic Analysis has the least information as it is compiling GDP data.

The net export deficit revealed that exports did grow more rapidly in the first quarter than initially thought: 7.5 percent rather than 3.2 percent. Unfortunately, imports grew 10.4 percent in the first quarter, not 2 percent as initially estimated. It is no wonder that currency traders are worried about the FX value of the dollar. Conventional wisdom asserts that a weaker dollar value will translate into stronger export demand and weaker import demand. However, as economic activity grows at a healthy pace in the U.S., it creates demand for all goods whether they produced domestically or not. Since the U.S. continues to grow more rapidly than most of its major trading partners, our seemingly insatiable demand for imports easily wipes out export gains.

Notice that real GDP grew more rapidly than final sales in both the fourth quarter of 2003 and the first quarter of 2004. Since inventory growth had lagged in the previous year, this is not a problem today. However, one should continue to monitor inventories in order to make sure than the accumulation is desired rather than unintentional. Unintended inventory accumulation signals the possibility that U.S. growth will moderate. We have not yet reached that point, however.

Labor market indicators
Nonfarm payroll employment has definitely been on an upswing in the past few months, but one would never know it by looking at the latest figures on new jobless claims and The Conference Board's help wanted index. The index has remained near all-time lows in May. In the first three weeks of June, jobless claims were averaging 345,000 per week, up a few thousand from average seen between March and May. Economists are predicting another healthy rise in nonfarm payrolls in June despite the less than stellar performance in these labor market indicators.

The Bottom Line
Economic news was relatively sparse this week with better-than-expected news (home sales, consumer sentiment) as well as worse-than-expected news (durable goods orders, GDP). On the whole, though, there is no question that economic activity continues to merrily skip along, as we are ready to begin a new quarter.

A host of key indicators will help to momentarily distract market players in the first half of the week as they wait for the Fed to announce its first interest rate hike in four years. The consensus is looking for a 25 basis point rate hike and surprises are unlikely from a rate perspective. Nevertheless, the Fed still has room to surprise market players with the word smithing of their post-FOMC statement.

It will be a heavy week as U.S. markets focus on economic indicators (including the employment situation) as well as the Fed. Moreover, geo-political events are constant concerns these days: the U.S. military is schedule to hand over administrative power to an interim Iraqi government on June 30th.

Looking Ahead: Week of June 28 to July 2

Monday
Personal income rose 0.6 percent in April after a 0.4 percent hike in March. Increases in wages and salaries are improving along with employment. Personal consumption expenditures increased 0.3 percent in April due to gains in durable goods and services. Nondurable goods spending decreased in April. May's retail sales gain bodes well for consumption expenditures.

Personal income Consensus Forecast for May 04: 0.5 percent
Range: 0.4 to 0.7 percent

Personal consumption expenditures Consensus Forecast for May 04: 0.8 percent
Range: 0.7 to 1.1 percent

Tuesday
The Conference Board's consumer confidence index edged up to 93.2 in May from a level of 93 in April. While job market conditions have improved lately, consumers are hurt by higher energy prices and rising interest rates.

Consumer confidence index Consensus Forecast for June 04: 95
Range: 94 to 99

Wednesday
The NAPM-Chicago jumped several points in May to reach 68, a level not seen since 1988. Keep in mind that the NAPM-Chicago covers both manufacturing and non-manufacturing activity. Nonetheless, market players still view this as a leading indicator of the ISM manufacturing index.

NAPM-Chicago Consensus Forecast for June 04: 64
Range: 60.8 to 67

After its semi-annual two-day meeting, the FOMC is expected to announce its first rate hike since May 16, 2000. The market consensus is looking for a "measured" 25 basis point hike that would bring the fed funds rate target to 1.25 percent. Market players will also be anxiously monitoring the post-meeting statement.

Fed funds rate target Consensus Forecast for June 04: 1.25 (+0.25) percent

Thursday
New jobless claims increased 13,000 in the week ended June 19 to 349,000, bringing the 4-week moving average to 344,250. Last week's drop was an anomaly since many state offices were closed in honor of former President Reagan's memorial. Thus far, June claims are up from May levels.

Jobless Claims Consensus Forecast for 6/26/04: 345,000 (-4,000)
Range: 337,000 to 350,000

The ISM manufacturing index edged up to 62.8 in May from the April level of 62.4. In both April and May, the ISM changed by a significantly smaller magnitude than predicted by the NAPM-Chicago. Market players would do well to consider the NAPM-Chicago cautiously in June.

ISM manufacturing index Consensus Forecast for June 04: 61
Range: 58 to 63

Construction spending rose 1.3 percent in April, the third straight monthly gain. Residential construction has continued to increase in recent months, although as housing starts dip, so well construction expenditures.

Construction spending Consensus Forecast for May 04: 0.7 percent
Range: -0.2 to 1.5 percent

Sales of domestically-produced motor vehicles jumped 9.2 percent in May to a 14.1 million-unit rate. Autos were sold at a 5.7 million-unit rate while light trucks were sold at an 8.6 million-unit rate. In both cases, vehicle sales were at their strongest pace since last December.

Light truck sales Consensus Forecast for June 04: 8.0 million-unit rate
Range: 7.8 to 8.5 million-unit rate

Auto sales Consensus Forecast for June 04: 5.5 million-unit rate
Range: 5.4 to 5.8 million-unit rate

Friday
Nonfarm payrolls increased 248,000 in May after growing more rapidly in March and April, but the rise was healthy. Factory payrolls increased 72,000 in May, the third straight monthly gain. The civilian unemployment rate remained unchanged at 5.6 percent in May. The average workweek also remained unchanged at 33.8 and hourly earnings rose 0.3 percent during the month.

Nonfarm payrolls Consensus Forecast for June 04: 250,000
Range: 195,000 to 285,000

Unemployment rate Consensus Forecast for June 04: 5.6 percent
Range: 5.5 to 5.7 percent

Average hourly earnings Consensus Forecast for June 04: 0.3 percent
Range: 0.2 to 0.3 percent

Average workweek Consensus Forecast for June 04: 33.8 hours
Range: 33.8 to 33.9 hours

Factory orders decreased 1.7 percent in April, reversing a portion of March's robust 5 percent hike. A sharp drop in durable goods orders accounted for the decline. Durable goods orders also fell in May, posting a 1.6 percent drop for the month.