BONDS
Interest rates are markedly higher in May relative to April. Treasury yields range from 6 basis points higher (at the long end) to 32 basis points higher (in the belly of the curve). This is not surprising given that the Federal Reserve altered its post-FOMC statement on May 4th and this was followed by a strong employment report on May 7th. While terrorist attacks continue to hold down yields in the risk-free Treasury market, rising stock prices along with rising oil prices this month have tended to boost yields. Treasury yields had also jumped in April as an apparent improvement in the labor market was viewed as a sign that the Fed would soon remove its policy accommodation. Bond investors have already factored in at least four 25 basis point increases in the federal funds rate target. If the Fed decides to raise the funds rate target by 25 basis points on June 30, it will be interesting to see if Treasury yields shoot up further or stabilize for a change.

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

Q1 GDP revised up
The Commerce Department's revised estimate revealed that real GDP grew at a 4.4 percent rate in the first quarter after increasing at a 4.1 percent rate in the fourth quarter of 2003. This was a slight upward revision from the advance estimate reported a month ago. While the overall growth rate was not significantly altered in the first quarter's first revision, the composition of growth showed slower investment spending on both structures and equipment & software. In contrast, consumer spending and residential investment were revised up modestly. Inventory growth expanded more dramatically while net exports deteriorated more sharply. Inventories have contributed sharply to real GDP growth in both the fourth quarter of 2003 and the first quarter of 2004 after declining for half of the year 2003. Some inventory building is considered desirable as demand for goods and services pick up steam. However, excessive inventory building can lead to production cuts if demand does not hold up. This is not a problem today, but it is good to continue to monitor inventory building vis-�-vis economic growth.

The GDP deflator increased at a 2.6 percent rate in the first quarter, virtually unchanged from the initial estimate of 2.5 percent but significantly higher than the fourth quarter's pace of 1.5 percent. The PCE deflator increased at a 3 percent rate in the first quarter, up sharply from the fourth quarter's pace of 1 percent. This was almost entirely related to energy & food prices, since the core PCE deflator (excluding food & energy prices) increased at a 1.7 percent rate in the first quarter after increasing at a 1.2 percent rate in the fourth quarter. Incidentally, Greenspan & Co. claim to prefer the PCE deflator to other inflation measures. The core PCE deflator has accelerated each quarter for the past year. Clearly, they will need to start becoming concerned with inflationary pressures even though they claimed in their May FOMC statement that the risk between inflation and disinflation was balanced.

Q1 Profits moderate
After-tax corporate profits rose 14.3 percent in the first quarter relative to the same period last year. However, this was a slight moderation from the 20.7 percent year-over-year gain recorded in the fourth quarter of 2003. Profits have managed to post yearly gains for eight straight quarters now. In the past few months, equity investors have become concerned that they were overly exuberant about the profit outlook. Stock prices have suffered although May was generally a positive month.

April durable goods orders fall
New orders for advance durable goods dropped 2.9 percent in April after surging for two straight months. Given the typical pattern for new orders, one shouldn't have been surprised although many economists had predicted a much smaller decline for the month. Both nondefense capital goods, a barometer of capital spending, and defense capital goods decreased sharply during the month despite increases in aircraft orders. Among the major categories of durable goods, only electrical equipment posted a rise for the month. Despite the disappointing orders report for April, the outlook remains favorable when one looks beyond the zigzag pattern. On average, new orders have increased 1 percent per month over the first four months of the year and this compares favorably with the past two years.

NAPM-Chicago jumps again
The NAPM-Chicago's business barometer index jumped nearly four points in May to reach 68 percent after jumping more than six points in April. Production, new orders, employment, and prices paid all picked up steam in May. Order backlogs, inventories and supplier deliveries moderated during the month but remained well above 50 percent. Market players look at the NAPM-Chicago as a predictor of the ISM manufacturing index. As indicated in the chart, the two certainly move in tandem much of the time - but not always and not by the same magnitude. It is important to keep in mind that the Chicago index incorporates both manufacturing and non-manufacturing activity. That said, the May index points to healthy activity in the Chicago region that perhaps may be indicative of robust activity across the country.

Home sales still rising
Sales of new single-family homes plunged 11.8 percent in April to a 1,093,000-unit rate after jumping 9.7 percent in March. In contrast, existing single-family homes increased 2.5 percent in April to a 6,640,000-unit rate after increasing 5.7 percent in March. Since existing home sales outnumber new home sales by a wide margin, total home sales managed to post a slight gain overall in April. It is not entirely surprising that consumers would still want to purchase new homes in this environment even though mortgage rates have pick up nearly 50 basis points in April over the March average. Rates remain low by historical standards, and consumers who have procrastinated until now may want to rush into the market before rates rise even more.

Labor market stagnant
New jobless claims were beginning to show decided improvement and then backed up again in May. Through the third week of May, the average level of new jobless claims is about on par with March and April. While remaining at these levels doesn't show a worsening labor market picture, neither does it show an ameliorating one. At the same time, the Conference Board's help wanted index remains in the doldrums, dipping back down to 38 in April after having reached a high of 40 just two months earlier. Perhaps help wanted advertising is not as popular as it once was since other means of hiring are available these days (Internet, referrals, etc.) but there is no apparent improvement here at all.

Consumer attitudes are mixed
The Conference Board's consumer confidence index inched up to 93.2 in May from a level of 93 in April. While labor market questions were partly improved, rising energy prices hurt consumers. The University of Michigan consumer sentiment index dropped four points in May from the mid-month reading as well as the final April reading and stood at 90.2 at the end of the month. The Michigan survey focuses on personal finance, which was clearly hit in May as consumers had to spend significantly more on gasoline. It remains to be seen how much these attitudes will affect retail sales in the near term. One has to believe that sharply higher gasoline prices will either curtail spending on gasoline (if consumers are able and willing to drive less) or curtail spending on non-gas purchases (which is more likely).

The Bottom Line
For the most part, economic news was friendly this week. First-quarter real GDP growth was revised slightly higher, home sales continued to grow, and the NAPM-Chicago index suggests that business activity was robust in May. Consumer attitudes were not showing much improvement, but then with a relatively stagnant labor market and rising gasoline prices, one is not likely to exude happiness.

Market players will definitely have to rest up on Monday as the week is chock full of economic indicators culminating with the mother of all indicators on Friday: the employment situation. The ISM manufacturing index on Tuesday, motor vehicle sales on Wednesday, and chain-store sales on Thursday will also be closely watched.

Looking Ahead: Week of June 1 to June 4

Tuesday
The ISM manufacturing index remained virtually unchanged in April at a high level of 62.4 percent. Production and employment were the two major components to increase in April; the remaining three components (new orders, inventories, and supplier deliveries) inched down. On the whole, this indicator suggests that manufacturing activity is percolating nicely.

ISM manufacturing index Consensus Forecast for May 04: 62 percent
Range: 58 to 64 percent

Construction spending increased 1.5 percent in March after posting a smaller 0.4 percent rise in February. A 0.8 percent rise in the residential sector helped to boost the total. Rising interest rates are likely to start curtailing growth in residential construction.

Construction spending Consensus Forecast for Apr 04: 0.5 percent
Range: -0.5 to 1 percent

Wednesday
Motor vehicle sales of domestically production vehicles decreased 1.5 percent in April to a 13.1 million-unit rate, as a drop in domestic autos to a 5.2 million-unit rate was not entirely offset by a rise in light truck sales to a 7.9 million-unit rate. Some automakers have re-introduced incentives on selected models, but incentives are running low compared to a couple of years ago when 0-percent interest loans were first introduced.

Domestic light truck sales Consensus Forecast for May 04: 7.9 million-unit rate
Range: 7.7 to 8.0 million-unit rate

Domestic auto sales Consensus Forecast for May 04: 5.4 million-unit rate
Range: 5.3 to 5.5 million-unit rate

Thursday
New jobless claims decreased 3,000 in the week ended May 22 to 344,000. This was the first drop, albeit small, after two straight weekly gains. In any case, the 4-week moving average inched up to 335,500 after four straight weekly declines but claims are below month ago levels. This bodes well for employment.

Jobless Claims Consensus Forecast for 5/29/04: 335,000 (-9,000)
Range: 335,000 to 340,000

The preliminary estimate showed that nonfarm productivity grew at a 3.5 percent rate in the first quarter after increasing at a 2.5 percent rate in the fourth quarter of 2003. At the same time, unit labor costs rose at a 0.5 percent rate in Q1 after remaining unchanged in the fourth quarter. Based on the minor revisions to first quarter GDP growth, major revisions are not expected for either productivity or costs.

Nonfarm productivity Consensus Forecast for Q1 04: 3.7 percent rate
Range: 3.6 to 4.0 percent rate

Unit labor costs Consensus Forecast for Q1 04: 0.3 percent rate
Range: 0.0 to 1.3 percent rate

The business activity index from the ISM non-manufacturing survey had jumped several points in April to reach 68.4 percent. This shows that business activity continued to expand at a healthy rate in the beginning of the second quarter.

Business activity index Consensus Forecast for May 04: 66 percent
Range: 64 to 70.2 percent

Factory orders jumped 4.3 percent in March after a healthy 1.1 percent gain in February. The outlook for April factory orders is less favorable since advance durable goods orders posted a 2.9 percent drop for the month. Both defense and nondefense capital goods orders fell during the month.

Factory orders Consensus Forecast for Apr 04: -1.5 percent
Range: -2.5 to -0.7 percent

Friday
Nonfarm payroll employment jumped 288,000 in April after a robust 337,000 gain in March. The bulk of gains stem from increases in the service-producing sector, but even manufacturing employment managed to post three straight monthly gains. The civilian unemployment rate edged back down to 5.6 percent in April after ticking up to 5.7 percent in March. The jobless rate has remained in a tight range since December 2003.

Nonfarm payrolls Consensus Forecast for May 04: 230,000
Range: 165,000 to 300,000

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

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