Recap of US Markets

STOCKS
The Fed's announcement was clearly viewed in a positive light by equity investors as both the Dow Jones industrials and the Nasdaq composite rose on Tuesday and Wednesday. But investors were not getting sufficiently good news on Thursday and Friday to extend the week's rally. Stock prices fell for the second straight week.

BONDS
The FOMC decision to keep rates unchanged and its accompanying statement that showed no hint of a rate hike any time soon were good news for the bond market. Indeed, the Treasury market rallied, with prices rising and yields falling. However, as the week ended, bond markets were trading on rumors that Osama bin Laden was or was not captured. Essentially, bonds can only trade in a tight range these days given a lack of new direction.

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.

Notice: I changed the way the euro-dollar exchange is reported in this table so that it is consistent with the yen-dollar exchange rate. Now the table will reflect euros per dollar. Thus an increase in this value represents a rise in the FX value of the dollar; conversely a drop in this value represents a decline in the FX value of the dollar.

The Economy

February inflation is mild relative to January
The consumer price index rose 0.3 percent in February after increasing 0.5 percent in January. Energy prices jumped 1.7 percent in February, considered mild after the 4.7 percent spurt in January. Food and beverage prices inched up 0.2 percent after edging down 0.1 percent the previous month. After all was said and done, consumers still had to cough up extra money to pay for basic necessities. Excluding food and energy prices, the CPI rose 0.2 percent for the second straight month. This seems tame but it is up from the 0.1 percent gain posted in December and the unchanged reading in November. The slightly faster pace of growth does not by any means suggest that inflation will be knocking on our doors tomorrow morning. However, deflation risks are concerns of the past. Notice that the year-over-year change in the core CPI ticked up in January and February after bottoming out at the end of 2003. Total inflation has moderated recently because of slower gains in energy prices. But then one can see that the total CPI fluctuates more dramatically than the core CPI.

The BLS finally released the January PPI after a 5-week delay. The PPI jumped 0.6 percent in January due primarily to a 4.7 percent spurt in energy prices (exactly in line with the energy price hike in the CPI for the same month). Food prices dropped 1.4 percent in January. Excluding food and energy prices, the PPI rose 0.3 percent, a moderate rise but significantly higher than the two previous months (-0.1 percent in December and 0.0 percent in November). A jump in motor vehicle and drug prices were largely responsible for the January gain in the core PPI. Notice that the core PPI is up 0.9 percent from a year ago. This is a meager rise but notice the upward trend in this index beginning mid-year 2003. If there was any doubt before, there shouldn't be now: deflation is dead. (We've noted that for several months already, but I keep reading about people who are still worried about deflation.)

Production accelerates in Q1-<% Response.Write(Year(Now)) %>
The index of industrial production rose 0.7 percent in February after an equally healthy 0.8 percent rise in January. As a result, the year-over-year rise in production is once again accelerating. Among major market groups, business equipment posted the largest rise in February (1.1 percent) followed by materials and consumer goods (0.7 percent for both). Among major industry groups, manufacturing production jumped 1 percent in February after sluggish behavior in January and December. Mining inched up 0.1 percent while utilities production declined 0.7 percent after surging 5.3 percent in the previous month. There is no question that the industrial sector is finally percolating. Even the capacity utilization rate has turned up to 76.6 percent, its highest level since August 2001. Granted, capacity utilization has a long way to go before supply bottlenecks and inflationary pressures kick in, but raw materials prices have already accelerated sharply.

Indeed, both the Empire State and Philadelphia Fed manufacturing surveys for March revealed sharp gains in prices paid and prices received even as general business conditions moderated from the heady pace of January and February. Diffusion indexes, where respondents are asked only about the direction of activity and not the magnitude of change, must be interpreted with caution. Nevertheless, any level above zero in these two surveys points to expanding manufacturing activity. The March levels for both are near 25, still high readings despite the drop from the previous two months. This suggests to us that the index of industrial production will probably continue to grow at a moderately healthy rate in March as well.

Another drop in housing starts
Housing starts fell 4 percent in February to a 1.86 million-unit rate after posting a 6.3 percent decline in January. Despite the two-month drop in starts, they are still 13.1 percent higher than a year ago! In any case, the Census Bureau, the agency that compiles the housing data, believes that it takes five months to establish a trend in starts. Thus, the chart below depicts total and single family starts on a five-month moving average basis. It does appear that housing starts probably peaked in December, but current levels are still strong by historical standards. Also, one should not discount the impact of falling mortgage rates. In the first three weeks of March, the mortgage rate on 30-year fixed rate loans averaged 5.46 percent, the lowest level since last June's all-time low (since the mortgage rate series began in 1971).

The Bottom Line
The Federal Reserve surprised no one by leaving the federal funds rate target unchanged at 1 percent at their meeting this week. A few word changes in the accompanying statement did not change the meaning of the statement.

While the Fed manufacturing surveys for March were somewhat weaker than expected, economic indicators were not far off from expectations this week. February activity was healthy as indicated by another strong rise in industrial production. Housing starts did fall for a second straight month, which will cause a decline in residential investment spending for the first-quarter GDP estimate, but the levels are still fairly robust.

Inflation indicators suggest that the long term improving trend may be over. While inflationary pressures are not likely to build soon, the new trend will point to rising inflation in the future. This means that the Fed will have to concern themselves with potential inflationary pressures even as the labor market remains stagnant. In the near term, wage increases are subdued because of slack labor markets. This means that inflationary pressures will not build quickly. But an improving industrial sector with rising capacity utilization coupled with sharply rising raw materials prices does eventually point to inflationary problems.

Market players will not focus on next week's GDP report since the final revision to fourth-quarter 2003 is not likely to be very interesting. However, corporate profits for the fourth quarter will be available for the first time. Market players will definitely focus on new jobless claims and the help wanted index to see if employment is showing even the smallest sign of life. Durable goods and home sales will also garner a lot of attention. Consumer sentiment will probably generate a flurry of activity in the markets if final March figures are stronger than the mid-month reading.

Looking Ahead: Week of March 22 to March 26

Wednesday
New orders for durable goods fell 2.3 percent in January after rising 1.7 percent in December. Machinery and transportation orders led the decline as new orders for primary and fabricated metals as well as computers & electronic products and electrical equipment all posted gains for the month.

Durable goods orders Consensus Forecast for Feb 04: 2 percent
Range: 0.4 to 3 percent

New single-family home sales fell 1.7 percent in January to a 1,106,000-unit rate after rising 1.3 percent in December. Sales have remained at fairly high levels but are nevertheless 7.8 percent below the 1,200,000 million-unit rate reached last June. Low mortgage rates suggest that housing will remain active for a while longer.

New home sales Consensus Forecast for Feb 04: 1,100,000-unit rate
Range: 1,025,000 to 1,140,000-unit rate

Thursday
New jobless claims fell 6,000 in the week ended March 13 to 336,000, the third straight weekly drop. This lowered the 4-week moving average to 344,000, also the third straight weekly decline. Claims, which will be down in March from the February average, should continue their downward trend, paving the way for employment gains to follow.

Jobless Claims Consensus Forecast for 3/20/04: 340,000 (4,000)
Range: 330,000 to 345,000

Economists are not predicting any significant change to real fourth-quarter GDP growth from the previous estimate of 4.1 percent. Final revisions tend to be minor among the various components and are usually offsetting. This report will include new information on fourth quarter corporate profits, which have not yet been released by the Commerce Department.

Real GDP Consensus Forecast for Q4-03: 4.1 percent rate
Range: 4.0 to 4.2 percent rate

GDP deflator Consensus Forecast for Q4-O3: 1.2 percent rate
Range: 1.1 to 1.2 percent rate

Existing single-family home sales fell 5.2 percent in January to a 6,040,000-unit rate after rising 3.9 percent in December. Monthly sales have fluctuated in a seesaw pattern over the past few months but remain at relatively high levels, although they are down from the September peak. Low mortgage rates suggest that housing activity will remain healthy for a while longer.

Existing home sales Consensus Forecast for Feb 04: 6.10 million-unit rate
Range: 5.95 to 6.25 million-unit rate

Friday
Personal income inched up 0.2 percent in January, boosted by wages and salaries. These should continue to help improve income growth in upcoming months. Personal consumption expenditures rose 0.4 percent in January with healthy gains in nondurable goods and services offsetting a plunge in durable goods spending. Retail sales rose moderately in February, pointing to another gain in consumption expenditures.

Personal income Consensus Forecast for Feb 04: 0.3 percent
Range: 0.2 to 0.4 percent

Personal consumption expenditures Consensus Forecast for Feb 04: 0.4 percent
Range: 0.2 to 0.6 percent

At mid-month, the University of Michigan's consumer sentiment edged down to 94.1 from February's final figure of 94.4. With a sluggish labor market and rising gasoline prices, it is not surprising that consumers aren't more optimistic about current conditions.