BONDS
Interest rates were generally higher the first week of June as bond investors saw strong economic news, culminating in another robust employment report. High energy prices didn't help. While OPEC agreed to increase production modestly, oil refinery capacity in the United States is limited. Consequently, gas pump prices are not likely to decline any time soon despite higher oil production by OPEC.

If there were any doubters remaining in the financial markets, the May employment report sealed the deal for a Fed rate hike at the end of this month. But bond investors have already priced in several rate hikes between now and the end of the year, thus Treasury yield gains were muted relative to the past two employment days in April and May when nonfarm payrolls finally began to post 'recovery-like' gains.

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

The job market is back!
Nonfarm payrolls rose 248,000 in May after upward revised gains of 346,000 in April and 353,000 in March. In just three months, job gains are approaching one million. But then 2.7 million jobs were lost between 2001 and 2003, so we do have a long way to go before regaining our previous peak in payroll employment. Nevertheless, the gains in the past few months are certainly encouraging as even factory payrolls have now increased for four straight months. Construction employment continues to expand at a healthy clip as well. Service sector jobs are becoming more abundant - and job gains for temporary workers are certainly in the minority.

The average workweek in the private sector has held steady at 33.8 hours for five straight months. This is higher than the 2003 level which averaged 33.67 hours for the year. In May, the factory workweek jumped 24 minutes to 41.1 hours from a level of 40.7 hours in April. As overtime hours increase, factory workers have more take-home pay for spending on goods and services. The May jump in hours worked along with the gain in payrolls point to a healthy jump in industrial production for the month. The overall rise in nonfarm payrolls and the steady workweek also bode well for income growth.

The civilian unemployment rate remained unchanged at 5.6 percent in May - holding at that level for four of the past five months. While nonfarm payrolls have posted healthy gains in the past few months, the same cannot be said for household employment, which since January has risen only one-third as fast. Given that household employment was growing more rapidly in 2003, it is not surprising that the two series are getting closer together. However, the employment-to-population ratio has remained in a tight, and low, range over the past several months. While there is no question that labor market conditions have improved in the past year, limitations are still evident.

The healthy nonfarm payroll gain will remove any concerns that the Fed may have had about beginning to remove their policy accommodation on June 30. Some market players have considered the possibility that the Fed would raise the fed funds target by 50 basis points instead of 25 basis points, but the lack of improvement in the employment-to-population ratio, an indicator closely monitored by Fed officials, suggests the larger rate hike would not follow the definition of a "measured pace". The bond market has already factored in a 2.25 percent fed funds rate target by year-end, but that may be premature unless the employment-to-population ratio begins to edge higher in coming months.

The ISM Surveys
The ISM surveys showed that economic activity continued at a gangbuster pace in May even though the non-manufacturing's business activity index moderated from the torrid level achieved in April. The manufacturing survey continued to inch higher. The business activity index has achieved a pace above 60 percent for five straight months and the ISM manufacturing index has surpassed the 60 percent mark for seven straight months. There is no question that these levels suggest domestic business activity is percolating.

April factory orders fall
After increasing for two months in a row - and recording a healthy 5 percent hike in March - factory orders dipped in April. Nondefense capital goods, a barometer of capital spending, as well as new orders for information technology goods also posted declines in April. Nevertheless, notice that recent gains are outstripping the declines over the past two years, showing the significant improvement in manufacturing that has already occurred. Of course, the manufacturing recession was deep and factory orders have yet to regain the previous peak reached in 2000. The May manufacturing surveys from the various Federal Reserve banks as well as the ISM survey and factory payrolls all point to robust manufacturing activity in the coming months.

Consumers ignore higher gas prices
Domestic motor vehicle sales jumped 9.2 percent to a 14.3 million-unit rate in May after averaging a 13.2 million-unit rate in the first four months of this year. Domestic autos were sold at a 5.7 million-unit rate while domestic light trucks were sold at an 8.6 million-unit rate for the month. Certainly, light truck sales have been higher but not in a period of rising gasoline prices. The percent of light trucks sold relative to the number of total (domestic) motor vehicles dipped in May to 60.1 percent from 60.5 percent in April. Light truck sales outnumbered autos by a slightly wider margin in December 2003 when they were 61.3 percent of the domestic motor vehicle sales sold. But gasoline prices were about 60 cents per gallon lower then.

On the whole, it appears that consumers did not refrain from purchasing gas-guzzlers in May despite the fact that gasoline prices are surpassing $2 per gallon in many regions of the country. Domestic automakers should be happy about that since profit margins on SUVs are significantly fatter than on cars. Moreover, the American makers still hold a larger share of the market for SUVs than foreign producers. While GM remains a major force even in the auto market, Ford's market share has declined rapidly. Toyota and Honda and to a lesser extent Nissan have been the primary beneficiaries of Ford's decline.

The Bottom Line
Employment is making a comeback and this will certainly allow the Fed to begin to remove its policy accommodation at a measured pace. Bond investors have already factored in at least five 25 basis point increases between now and year end. It is a good bet that the Fed increases the funds rate target by 25 basis points on June 30, the second day of their semi-annual two-day meeting.

Next week's indicators are more sparse in comparison to this past week. Market players will be focusing on inflation issues with import prices on Thursday and the PPI on Friday.

Looking Ahead: Week of June 7 to June 11

Monday
Consumer installment credit expanded by $5.7 billion in March after a meager $0.9 billion gain in February. April motor vehicle sales were sluggish and this should hamper credit demand for the month, along with the soggy retail sales figures.

Consumer credit Consensus Forecast for Apr 04: $5.9 billion
Range: $1 to $9 billion

Thursday
New jobless claims decreased 6,000 in the week ended May 29 to 339,000. This was the second drop, but followed two weekly gains which were larger than the declines. Despite the two declines, the 4-week moving average increased to 341,000. On the whole, May claims are down from April levels.

Jobless Claims Consensus Forecast for 6/5/04: 335,000 (-4,000)
Range: 328,000 to 340,000

Import prices inched up 0.2 percent in April after a larger 0.8 percent spike in March. The March hike was mainly due to a spurt in oil prices. Excluding petroleum, import prices rose 0.3 percent in April. Export prices rose at 0.6 percent in April. In recent months, prices of agricultural products have picked up steam boosting the total.

Import prices Consensus Forecast for May 04: 0.8 percent
Range: 0.5 to 1.2 percent

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

The federal budget surplus amounted to $17.6 billion in April, significantly lower than the average April surplus of $93.9 billion over the previous ten years. In May, the deficit has averaged $43.7 billion over ten years. Given the trend towards higher monthly deficits and smaller surpluses, it is likely that the May deficit will surpass the average.

Treasury budget Consensus Forecast for May 04: -$70 billion
Range: $-90 to $-60 billion

Friday
The producer price index jumped 0.7 percent in April after a 0.5 percent hike in March. Energy and food prices have posted large gains in recent months. Excluding food and energy prices, the PPI increased 0.2 percent in both March and April.

PPI Consensus Forecast for May 04: 0.6 percent
Range: 0.4 to 1.2 percent

PPI ex food & energy Consensus Forecast for May 04: 0.2 percent
Range: 0.1 to 0.3 percent

The international trade balance on goods and services widened to $46 billion in March after reaching a $42.1 billion shortfall in February. Exports did rise during the month but were outpaced by gains in imports.

International trade balance Consensus Forecast for Apr 04: $-45 billion
Range: $-47.5 to $-44 billion

The University of Michigan's consumer sentiment index dropped several points in May to 90.2 after reaching a level of 94.2 in March. Consumer finances were hit by rising mortgage rates as well as higher gasoline prices and this likely dampened consumer optimism to some degree.