Greenspan, again
President Bush nominated Alan Greenspan to his fifth term as chairman of the Federal Reserve this past week. It was not a surprise given that Bush indicated last year that he would indeed nominate Greenspan to another four-year term that ends in 2008. Unfortunately, Greenspan's term as a Fed governor is due to expire February 1, 2006, and according to the bylaws of the Federal Reserve Act of 1913, he cannot be re-appointed to another 14-year term. Greenspan was initially appointed in 1987 to finish an unexpired term. Greenspan will be allowed to continue his role as chairman for a minimal period until a replacement can be found, but not too many months past the February 1 expiration.
Already several names have been bandied about as potential replacements for the Fed chairman. Of course, the names differ whether one assumes that Bush is re-elected or whether Kerry wins in November. Martin Feldstein tops the list of candidates in a Republican win. There are no odds on the Democratic side, although Robert Rubin and Larry Summers are two names that pop out. One of my favorite former Fed governors was mentioned in a Financial Times article, Larry Meyer. But unfortunately, he seems more of a long shot at this point.
Fed officials in the news
Many Fed officials were on the speaking circuit this week, giving financial market players something to trade on other than geopolitical events. Several of the officials mentioned raising rates. We often hear Ben Bernanke, Al Broaddus, Bob McTeer, and even Anthony Santomero comment on the economy. This week, Minneapolis Fed President Gary Stern spoke out on economic issues on CNBC. Stern does not often speak out and his comments suggest that the Fed does indeed stand ready to raise rates even in an election year.
Recap of US Markets
STOCKS
While the bond market ended up pretty much where it began the week, stock price action was much more dramatic. And stock prices ended lower despite climbing out of the hole early in the week. The stock market has not fared well on days in which terrorist attacks dominate the news. The week began with an assassination in Iraq. It was not a pretty week. Oddly enough, the Nasdaq composite index, after several tough weeks, managed to hold its own.
BONDS
Terrorist attacks, oil prices and Fedspeak generally drove the market this week. Whenever issues in Iraq worsen, bond yields tend to dip as they did early in the week. Fed officials were on the chicken circuit this week and generally caused market movements (in both directions). Many bond traders are coming to the view that it is best to just watch Fed actions and ignore whatever Fed officials are saying since new terms pop up everyday or old runs are redefined. For instance, bond investors are just coming to terms with "measured pace" but were hit with a new phrase by Ben Bernanke this week. It seems that the Fed has not yet made an "unconditional commitment" to raise the federal funds rate target. Fed governors and bank presidents were out in droves this week, and bond investors probably paid more attention than usual because hard-core economic news was lacking. After all was said and done, Treasury yields were virtually unchanged from last Friday's close.
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
April housing dips
Housing starts fell 2.1 percent in April to a 1.97 million-unit rate after rising 6.1 percent in March to a 2.01 million-unit rate. According to the Census Bureau, a five-month moving average establishes the trend in housing starts. By this method, starts peaked in January and March at a 1.992 million-unit rate, but dipped to a 1.975 million-unit rate in April. The spurt in housing starts between August and January is notably related to declining mortgage rates. As mortgage rates have ticked higher once again, it appears that housing activity may cool off a bit. While rising mortgage rates make monthly mortgage payments more expensive and reduce the number of households who can afford them, the improving labor market situation will help offset the negatives. After all, higher employment tends to generate higher income.
There is no question that the rising interest rate environment is hampering refinance activity. Using the smoothed data (4-week moving average) refinancing activity is down more than 25 percent since the end of January, although as one can see from the chart below, refinancing is still higher than the December low. Rising rates will continue to curtail refinancing, and this will limit the additional monies that consumers could generate by cash-out refinancing.
It will be interesting to see whether new homes are going to be built with additional efficiencies in the coming year as energy prices remain at high levels. The improved efficiencies that took place in the 70s and 80s because of the 70s energy crisis are legendary. In reality, energy prices were higher 20 years ago after adjusting for inflation. But it appears that money illusion is causing many consumers heartburn over the pump price at the local gas station. Consumers have yet to really look at higher home fuel costs due to a hot summer (air conditioning) or a frigid winter (heating).
Manufacturing continues to expand
Two key manufacturing surveys conducted by the Philadelphia Fed and the New York Fed showed a slight moderation in general business conditions but they still reflect an expanding manufacturing sector. The Philadelphia Fed's index fell back to 23.8 in May from 32.5 in April while the Empire State Manufacturing index decreased to 30.2 in May from 34.3 in April. In both cases, the general business conditions index for 6-months hence increased in May from the April level suggesting the outlook for the upcoming six months is robust.
The Bottom Line
Economic news was generally benign this past week as two closely followed Fed surveys showed that manufacturing activity was continuing to expand at a healthy rate in May, albeit slower than the previous month. Housing starts dipped in April, not surprising in light of the rising mortgage rate environment, but still fairly strong. New jobless claims rose for the second straight week, but the 4-week moving averaged dipped for the fourth straight week. Claims are down from the same period a month ago - and this bodes well for employment.
Oil prices and the Fed dominate the news. Market players are worried about rapidly rising rates, but on the flip side, are worried that the Fed will not do enough to prevent inflationary pressures from developing in light of rising energy prices. Higher oil prices may also act as a tax on consumers, who will be left with less discretionary income at the end of the month after they fill up their gas tanks. This could put a lid on consumer spending for more than a month or two. Again, improving labor market trends may help improve the earnings scenario and offset some of the negative impact of rising energy prices.
Looking Ahead: Week of May 24 to May 28
Tuesday
The Conference Board's consumer confidence index increased more than four points in April to 92.9 from a level of 88.5 in March. It has shown more improvement in the past couple of months than the University of Michigan survey because it is geared towards job questions, while the latter is not.
Consumer confidence index Consensus Forecast for May 04: 94
Range: 90 to 96.5
Existing home sales jumped 5.7 percent in March to a 6.48 million-unit rate after increasing 2.2 percent in February. Home sales were benefiting from the dropping mortgage rates through March. Some procrastinators may still be entering the market in April. The MBA purchase applications index was still going strong in April and early May.
Existing home sales Consensus Forecast for Apr 04: 6.45 million-unit rate
Range: 6.25 to 6.60 million-unit rate
Wednesday
New orders for durable goods jumped 5 percent in March after a healthy 3.9 percent spurt in February. Orders were strong across the board including primary metals, fabricated metals, machinery, computers and transportation.
Durable goods orders Consensus Forecast for Apr 04: -0.8 percent
Range: -3.5 to 1.5 percent
New home sales surged 8.9 percent in March to a 1,228,000-unit rate as homeowners took advantage of low mortgage rates. In the meantime, mortgage rates have risen and it remains to be seen whether home sales can remain at these high levels.
New home sales Consensus Forecast for Apr 04: 1,191,000-unit rate
Range: 1,100,000 to 1,250,000-unit rate
Thursday
New jobless claims rose 12,000 in the week ended May 15 to 345,000. This was the second week in a row in which claims rose. Nevertheless, the 4-week moving average dipped for a fourth straight week and claims are below month ago levels. This bodes well for employment.
Jobless Claims Consensus Forecast for 5/22/04: 335,000 (-10,000)
Range: 325,000 to 345,000
The Commerce Department's advance estimate revealed that real GDP grew at a 4.2 percent rate in the first quarter after increasing at a 4.1 percent rate in the fourth quarter of 2003. Typically, the largest revisions occur in business inventories and net exports since these are the sectors with the least information when the advance estimate is compiled.
Real GDP Consensus Forecast for Q1 04: 4.6 percent rate
Range: 4.2 to 4.8 percent rate
GDP deflator Consensus Forecast for Q1 04: 2.5 percent rate
Range: 2.1 to 2.6 percent rate
The Conference Board's help wanted index inched down to 39 in March after reaching 40 in February. Help wanted advertising has not shown any marked improvement in the past year. This is a sore spot for the economy.
Help wanted index Consensus Forecast for April 04: NA
Range: NA
Friday
Personal income inched up 0.4 percent in March after increasing 0.5 percent in February. The improved labor market situation should help to boost income in coming months. Personal consumption expenditures rose 0.4 percent in February and March. The April retail sales figures suggest that April consumption expenditures will be less robust than in the past few months.
Personal income Consensus Forecast for Apr 04: 0.5 percent
Range: 0.3 to 0.7 percent
Personal consumption expenditures Consensus Forecast for Apr 04: 0.3 percent
Range: 0.1 to 0.6 percent
The NAPM-Chicago index jumped several points in April to reach a level of 63.9. The jump in the Chicago index was not matched by an equal rise in the ISM manufacturing survey. Keep in mind that the NAPM-Chicago covers non-manufacturing as well as manufacturing activity.
NAPM-Chicago Consensus Forecast for May 04: 60.2
Range: 58.5 to 62.5
The University of Michigan's consumer sentiment index remained unchanged at the mid-May reading from the April level of 94.2. Market players were expecting a higher reading but remember that the Michigan survey does not relay on job market questions, which has helped to propel the Conference Board's consumer attitude survey.
Consumer sentiment Consensus Forecast for May 04: 94
Range: 92 to 95
Fedspeak dominates the news
