BONDS
Oddly enough, Treasury yields are down from a month ago. Why is that odd' One would expect that yields would rise as economic activity continues on a solid path, one that will eventually lead to Fed rate hikes. But Fed officials continue to say "they can be patient" in raising the federal funds rate target. Treasury securities are also in demand by foreign central banks as they sop up dollars and need a holding facility for them. On Friday, buying by indexed funds also helped spur a late afternoon rally that further dampened yields. Finally, many bond investors are thinking that February nonfarm payrolls are likely to be weak. Economists have overestimated payrolls for the past several months, so bond investors have cause to be wary.

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

Greenspan's chicken circuit
Fed chairman Alan Greenspan was quite busy this week as he spoke on a variety of issues. He began the week by discussing household debt obligations and noting that debt service has been stable over the past couple of years. This puts the household sector in pretty good shape. Furthermore, he noted that net worth is increasing along with debt. As long as net worth does increase, it makes the debt burden less onerous on households.

Tuesday's topic was focused on government-sponsored enterprises: Fannie Mae and Freddie Mac. According to Greenspan, these agencies have taken on too much debt and too much risk. Greenspan is concerned that growth in these two agencies has proliferated because investors believe that they are "too large to fail" and that the federal government would prevent them from defaulting on their debt. Greenspan is also concerned that Fannie and Freddie are increasing their profit margins by bearing low credit risk at the expense of private firms.

Greenspan's testimony on Wednesday elicited a lot of ire among consumers. My local paper is still covering the topic - three days later! Greenspan addressed the House Committee on the Budget and discussed fiscal responsibility. He insisted that the budget deficit be restricted by reducing spending rather than increasing taxes. The spending cuts were to be focused on Medicare and Social Security payments since Baby Boomers were too large a group to support. Oddly enough, Greenspan didn't say anything new. The problem of supporting Baby Boomers in their old age has been an issue for at least 10 if not 20 years. But Greenspan's solution was to scale back social security benefits without increasing taxes at all. While this is usually viewed as the typical Republican solution, even President Bush came out and declared that social security benefits would not be changed in the near term.

Greenspan took a break on Thursday and will speak at the Stanford Institute for Economic Policy Research on intellectual property rights on Friday night. The topic should not generate excessive controversy in the financial markets.

On the whole, Greenspan was rather controversial this week as he roiled congressional leaders on fiscal policy issues and the direction of government sponsored enterprises.

Mixed results in manufacturing
Total new orders for durable goods dropped 1.8 percent in January, more than reversing December's 1.6 percent hike. A sharp drop in aircraft orders along with a decline in motor vehicle orders caused the January plunge. Excluding the volatile transportation industry, new orders rose 2 percent in January following a 1.7 percent gain in December - not a bad result for the two-month period. Orders were stronger for a variety of industries including primary and fabricated metals, computers & electronics and electrical equipment & appliances. In addition to transportation, new orders for machinery declined in January as well. Nondefense capital goods order, a leading indicator for business fixed investment spending, rose 1.5 percent in January after a 4 percent spurt in December. It seems that the first quarter of 2004 is off to a good start.

The prospect for February manufacturing activity is favorable. The NAPM-Chicago business barometer edged down to 63.6 in February from a level of 65.9 in January, but still reflects a percolating market. The Chicago index covers manufacturing as well as non-manufacturing activity, but there is no question that the Chicago index is a good leading indicator for the nation. While new orders fell back to 67.5 percent in February from 69.7 percent, the overall level of activity remains high. Any level above 50 percent reflects growth.

Home sales decline again
Sales of new single-family homes dipped 1.7 percent in January while sales of existing single-family homes dropped 5.2 percent during the month. In both cases, the sales decline more than reversed the December gains. Total home sales are now down 8.5 percent from their September 2003 peak. There is no question that sales in January were curtailed by unusually severe weather. Sales declines were steepest in the Northeast and the Midwest among existing homes. Home sales in the South performed the best during the month.

Mortgage rates continued their downward slide after peaking this summer at 6.26 percent in August. In February, 30-year fixed loan rates averaged 5.64 percent. Lower mortgage rates may once again help boost housing activity in the next few months, but housing experts are predicting that 2004 sales won't be as strong as the 2003 selling pace. Keep in mind that this translates into weaker spending on furniture and appliances as well.

Confidence slips
The University of Michigan's consumer sentiment index dropped 9.4 percentage points to 94.4 in February while the Conference Board's consumer confidence index declined 9.1 percentage points to 87.3 for the month. While the two series, which have different focuses, don't always move in tandem, both declined in February after extraordinary increases in January. While some economists are suggesting that poor weather conditions in February hurt the index, it appears to us that the January increase was probably overblown. Following the trend from December, it appears that consumer attitudes are fairly stable these days, with a slight upward bias. If only the labor market would improve significantly, confidence surveys would reflect more optimism.

Labor market stagnant
The Conference Board's help wanted index edged up a tick to 38 in January from December's level of 37. No doubt about it, the index is treading water. The index hasn't exhibited these low levels since mid-1960. Jobless claims for the full month of February will probably post their first monthly increase since April after declining or remaining unchanged for the past several months. The February level is averaging 354,000 for the three weeks of February currently available; at least claims haven't surpassed the 400,000 mark again. These figures don't bode well for February nonfarm payroll employment (released Friday).

GDP holds the 4 percent mark
The Commerce Department's first revision to Q4-2003 revealed that real GDP grew at a 4.1 percent rate, a tick better than the initial estimate of 4 percent growth. This was a surprise to a majority of economists who were expecting a downward revision to the fourth quarter figures. The largest upward revision was in business fixed investment and inventory accumulation. Personal consumption expenditures growth was barely changed at 2.7 percent (from 2.6 percent) and residential investment growth was revised down two percentage points to 8.6 percent. The largest downward revision was in net exports; while export growth was revised up, so was import growth and that acts as a drag on GDP growth. All in all, the GDP figures showed solid growth in the economy in the fourth quarter.

The Bottom Line
Economic news wasn't bad this week with several indicators coming in slightly higher than expected. Even though durable goods orders declined, the drop was concentrated in the volatile transportation sector. This suggests that manufacturing activity continues to climb. The healthy level of the NAPM-Chicago supports that view as well.

Home sales dropped in January primarily due to extreme weather conditions. Low mortgage rates suggest that housing activity should continue at a decent pace in 2004, but not as strong as last year.

The main problem facing the economy is a stagnant labor market. Fed Chairman Greenspan suggested on more than one occasion that productivity growth is likely to slow in coming months, which will help to boost employment growth.

Greenspan was very much in the news this past week, giving speeches or testifying before Congress. His comments on cutting back social security benefits did not sit well with consumers or congressional leaders.

Next week's indicators -- ISM surveys, motor vehicle sales, the employment situation report -- will focus on February. Incidentally, the Labor Department still hasn't said when it will release January PPI figures, which are now 10 days overdue!

Looking Ahead: Week of March 1 to March 5

Monday
Personal income inched up 0.2 percent in December, in line with the gains of the past several months which have followed a tight 0.2 - 0.3 percent range. In December, wages and salaries decreased 0.3 percent; luckily, accelerated gains in transfer payments and proprietors' income made up the difference. Nevertheless, real disposable income was unchanged for the month after growing 0.4 percent in November.

Personal consumption expenditures rose 0.4 percent in December, boosted by a spurt in durable goods for the second straight month. Spending on nondurables was unchanged in December. January retail sales show a drop in motor vehicle sales and furniture store sales but healthy gains in nondurable categories.

Personal income Consensus Forecast for Jan 04: 0.5 percent
Range: 0.4 to 0.8 percent

Personal consumption expenditures Consensus Forecast for Jan 04: 0.4 percent
Range: 0.0 to 0.6 percent

The ISM manufacturing index inched up to 63.6 in January from a level of 63.4 in December. Despite the tiny change from December to January, there is no question that manufacturing activity expanded at a healthy rate in both months. Two Fed surveys from the Philadelphia Fed and the New York Fed suggest that manufacturing activity continued to grow in February as well.

ISM manufacturing index Consensus Forecast for Feb 04: 61.5
Range: 57 to 63.3

Construction spending increased 0.4 percent in December after a 0.5 percent gain in November. Construction expenditures were stronger from July through October, but residential investment has moderated over the past six months.

Construction spending Consensus Forecast for Jan 04: 0.3 percent
Range: -0.5 to +1.0 percent

Tuesday
Domestic motor vehicle sales plunged 10.3 percent in January after a healthy spurt in December. Domestic autos were sold at a 5.2 million-unit rate in January, down 8.8 percent from the December selling pace. At the same time, domestic light trucks were sold at a 7.9 million-unit rate, 12.2 percent below December's healthy selling rate.

Light truck sales Consensus Forecast for Feb 04: 8.0 million-unit rate
Range: 7.7 to 8.9 million-unit rate

Auto sales Consensus Forecast for Feb 04: 5.4 million-unit rate
Range: 5.2 to 5.5 million-unit rate

Wednesday
The business activity index from the ISM non-manufacturing survey jumped nearly eight points in January to reach a level of 65.7 percent, a new peak for this index. New orders posted a healthy gain, although the employment components edged down a few ticks (but remained above 50 percent). The price index has remained well above the 50 percent mark since March 2002.

ISM non-manufacturing survey Consensus Forecast for Feb 04: 63.5
Range: 60 to 65.5

The Fed's Beige Book will be closely monitored for signs of price pressures and for improvement in labor market conditions. Market players will also be interested in noting retail sales gains and the strength of the housing market.

Thursday
New jobless claims rose 6,000 in the week ended February 21 to 350,000. This boosted the 4-week moving average to 354,750, the fourth straight weekly rise. Claims are up in February, the first monthly gain since last April. This does not bode well for the labor market.

Jobless Claims Consensus Forecast for 2/28/04: 345,000 (-5,000)
Range: 340,000 to 355,000

Nonfarm productivity was initially estimated to have grown at a 2.7 percent rate in the fourth quarter, and since real GDP growth was nearly unrevised, don't expect much change to productivity figures for the quarter. Unit labor costs were estimated to have declined at a 1.3 percent rate in Q4; expect a similar rate of decline.

Nonfarm productivity Consensus Forecast for Q4-03: 2.6 percent annual rate
Range: 2.2 to 3.5 percent annual rate

Unit labor costs Consensus Forecast for Q4-03: -1.2 percent annual rate
Range: -1.6 to -0.8 percent annual rate

Factory orders rose 1.1 percent in December, reversing the November drop. While durable goods orders increased 1.6 percent in December, nondurable goods orders jumped 2 percent for the month. Durable goods orders, however, declined in January and this will put downward pressure on total factory orders.

Factory orders Consensus Forecast for Jan 04: -0.5 percent
Range: -1.0 to 0.0 percent

Friday
The civilian unemployment rate edged down to 5.6 percent in January from 5.7 percent in December. The downward trend in the jobless rate is mainly due to a declining labor force rather than expanding employment. Nonfarm payrolls increased 112,000 in January, more than the past few months but still less than predicted by economists.

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

Nonfarm payrolls Consensus Forecast for Feb 04: 125,000
Range: 35,000 to 170,000

Average workweek Consensus Forecast for Feb 04: 33.8
Range: 33.7 to 33.8

Average hourly earnings Consensus Forecast for Feb 04: 0.2 percent
Range: 0.1 to 0.3 percent

Consumer installment credit expanded $6.6 billion in December after a meager $1.8 billion gain in the previous month. December credit expansion was boosted by a spurt in motor vehicle sales. Auto and light truck sales fell in January and this may hold down the total.