BONDS
Often when equity investors are in a funk, bond investors will rally. Treasury prices have in fact rallied dramatically since the dismal February employment report. After all, why would the Fed try to raise rates when labor market conditions suggest economic growth is limited this year' While it does seem that the deflation camp has decamped, inflation is still not a major concern in this economy. Signs of economic activity are proliferating. For instance, the capacity utilization rate, which is considered a barometer of price pressures, has jumped in the past year. But true inflationary pressures are at least six months off, if not more.

Treasury markets were further bolstered by the terrorist attack in Madrid on Thursday. These securities are considered a safe-haven investment and always benefit from disastrous situations. However, by week's end, just as stocks rallied on Friday, bond prices dipped slightly. No matter, yields are still down 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.

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

Retail sales show strong momentum
Retail sales increased 0.6 percent in February after upwardly revised gains in both December and January. Some of the upward revisions stemmed from stronger sales at motor vehicle dealers, but non-auto retail sales were also revised up in the two previous months. But sales in the non-auto sector were unchanged in February due to declines in a good number of the categories. More categories of retailers posted declines than increases. A few sectors rose: sales jumped 1.3 percent at general merchandise stores, 0.5 percent at electronics & appliance stores, and 0.4 percent at clothing & accessory stores.

On the whole, retail sales have been pretty good over the past year. We tend to get bogged down in the ups and downs of monthly sales that are affected by exogenous events such as blizzards. In fact, since July 2003, total retail sales have posted average monthly gains of at least 0.5 percent per month for 12 straight months. That is, taking a 12-month moving average of retail sales reveals that sales were consistently rising at least 0.5 percent per month if not more. In February 2004, the 12-month moving average showed a 0.7 percent gain, signifying a rising trend in retail sales despite the lower-than-expected rise in February.

While a good number of categories have been strong over the past year, a couple have failed to increase as much as the average. For instance, average monthly sales for food & beverages have generally run 0.3 to 0.4 percent in the past several months. Sales at sporting goods, hobby, book & music stores have only recently started averaging monthly gains of 0.2 percent, whereas sales had declined for several months. Miscellaneous store retailers have also averaged 0.2 to 0.4 percent monthly gains in the past year. Through February, the strongest 12-month gains are at building materials stores, followed by furniture & home furnishing stores, and electronic & appliance stores.

Monthly volatility often obscures underlying trends. It is useful to step back and monitor longer term trends in the retail sector, which reveal where consumers are truly spending their hard-earned dollars.

Trade deficit regains ground
The international trade deficit increased to $43.1 billion in January, reaching a new high for the history of this series after moderating during 2003. Imports fell 0.5 percent in January, whereas exports decreased 1.2 percent. On a year-over-year basis, imports rose 8.2 percent while exports increased 8.5 percent. However, given that the level of imports is almost 50 percent higher than the level of exports, an increase in imports gets magnified. There is no question that the moderate pace of economic growth in the U.S., coupled with a declining FX value of the dollar over the past year has helped curtail import demand. At the same time, the weak dollar boosted U.S. exports. Unfortunately, the U.S. propensity to import is significantly larger than many of its trading partners, making it more difficult to stem the flow of foreign goods. Moreover, many of our trading partners have grown at a slower pace in the past year, dampening the demand for our exports. Absent significant trade barriers, a weaker dollar should continue to promote U.S. exports and limit purchases of imports.

Import prices moderate, export prices accelerate
This time of the month, we would typically be covering the latest producer price index release. The January release was postponed in February; now the February release, originally scheduled for release on March 12th, has also been postponed. The Bureau of Labor Statistics (BLS) is converting the industry classifications from the old SIC (Standard Industrial Classification System) to NAICS (rhymes with "bakes", North American Industrial Classification System). Nearly all economic releases have been converted to NAICS in the past couple of years. The BLS wants to report accurate information and would rather not release the PPI report in bits and drabs. As a consequence, PPI figures have been delayed.

It's a good thing that inflation is not a serious concern these days; missing the PPI figures for a month or two is not a serious problem. However, sometimes the PPI gives us information that can improve the CPI forecast for the month. Last month's CPI, which was a bit of a surprise, might not have been a surprise at all had economists seen the PPI figures first. As such, we must glean some information from import & export prices.

Notice that import prices fluctuate more sharply than export prices. This is due, of course, to energy. Petroleum import prices inched up only 0.2 percent in February after surging 8.2 percent in January, 4.3 percent in December and 2.1 percent in November. Despite the sharp gains of the three previous months, petroleum import prices are down 4.9 percent from a year ago. Prices of non-petroleum imports rose 0.4 percent in February, half as much as the 0.8 percent spurt recorded in January. These prices are 1.8 percent higher than a year ago.

Total export prices rose 0.6 percent in both January and February. In February, however, prices of agricultural exports jumped 1.2 percent after decreasing 0.2 percent in the previous month. Prices of non-agricultural exports rose 0.6 percent in both months.

On the whole, these figures don't suggest that inflationary pressures will be upon us soon. The significant moderation in oil import prices in February could suggest that energy prices will soften in the February CPI. Similarly, the 1.2 percent spurt in agricultural export prices might suggest that food prices spurted in the CPI for the same month. The February consumer price index will be reported next Wednesday.

The Bottom Line
One can hardly call the economic news "bad" this week but a good chunk of it was slightly weaker than expected. Yet the data, together with the attack in Madrid, played on negative psychology. Equities sank and Treasuries, helped by safe-haven buying, rallied again.

The FOMC meeting next week is unlikely to yield any surprises. While there is no question that economic growth is proceeding at a moderately healthy rate, we still haven't seen any labor market improvement. Fed Chairman Alan Greenspan did say this week he expects job growth to accelerate, but he made no promises, just a prediction. Other economists also expect job growth to accelerate - eventually. It's just that no one knows when it will actually happen.

Thus the Fed is unlikely to change the fed funds rate target from 1 percent. There is a chance that the FOMC might want to update their post-FOMC statement, but they have already moved from "considerable period" to "can be patient". However, they can alter their statement on their perception of economic growth or inflation.

Looking Ahead: Week of March 15 to March 19

Monday
The Empire State Manufacturing index increased more than three points in February to 42.1 from a level of 38.9 in January. Any level above zero represents a growing manufacturing sector. At these high levels, the index suggests fairly healthy activity in the New York state region.

Empire State manufacturing index Consensus Forecast for Mar 04: 37.5
Range: 30 to 40

The index of industrial production jumped 0.8 percent in January after remaining unchanged in December. On the whole, industrial production has been exhibiting a healthy upward trend in the past several months. While the employment report was bleak, there were some signs of improvement in the manufacturing sector with virtually no change in factory payrolls (after sharp declines for several years) and an increase in the factory workweek. This bodes well for industrial production in February.

Industrial production Consensus Forecast for Feb 04: 0.4 percent
Range: 0.0 to 0.8 percent

Capacity utilization rate Consensus Forecast for Feb 04: 76.4 percent
Range: 76.1 to 76.8 percent

Tuesday
Housing starts dropped 7.9 percent in January to a 1.90 million unit rate after reaching a high 2.07 million unit rate in December. Most likely, the sharp January decline was due to more severe than usual winter weather conditions which hampered construction - particularly in the Northeast and Midwest. Mortgage rates continue to decline and this could help housing for a few more months.

Housing starts Consensus Forecast for Feb 04: 1.90 million unit rate
Range: 1.83 to 2.00 million unit rate

The Federal Open Market Committee is meeting on Tuesday to determine the course of monetary policy for the next eight weeks. At this time, given February's bleak employment report, no one expects the Fed to raise rates. While the Fed just recently changed the wording of their post-FOMC statement, market players will still be watching for more word changes, just in case.

Federal funds rate target Consensus Forecast for Mar 16 04: 1 percent (unchanged)

Wednesday
The consumer price index increased 0.5 percent in January due primarily to a 4.7 percent spurt in energy prices. Food & beverage prices dipped 0.1 percent for the month. Excluding these two volatile components, the core CPI rose 0.2 percent during the month. CPI changes are on trend and not a cause for concern these days (showing neither deflationary nor inflationary pressures.)

CPI Consensus Forecast for Feb 04: 0.3 percent
Range: 0.2 to 0.5 percent

CPI ex food & energy Consensus Forecast for Feb 04: 0.1 percent
Range: 0.1 to 0.3 percent

Thursday
New jobless claims fell 6,000 in the week ended March 6 to 341,000. This was the second week in a row in which new claims fell modestly. The 4-week moving average has also declined over the past two weeks. New claims rose for the month of February; perhaps they will fall back again in March. At least, the month has begun on a hopeful note.

Jobless Claims Consensus Forecast for 3/13/04: 345,000 (4,000)
Range: 337,000 to 350,000

The index of leading indicators rose 0.5 percent in January after a 0.2 percent rise in December. Thus far, the index is about balanced in February. The factory workweek increased, as did vendor performance and stock prices. However, new jobless claims rose - which turns into a negative in this index. Furthermore, the spread between the 10-year note and the fed funds rate remains negative and consumer expectations plunged.

Leading indicators Consensus Forecast for Feb 04: 0.1 percent
Range: -0.2 to 0.2 percent

The Philadelphia Fed survey's general conditions index fell back to 31.4 in February after reaching a high level of 38.8 in January. Even with a slight setback, there is no question that manufacturing activity is percolating in the Philly Fed region. This index is closely watched as a precursor for industrial production and the ISM manufacturing index