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Simply Economics will be taking next week off
Simply Economics will return on Friday, December 31, 2010
Merry Christmas and Happy New Year
from all of us at Econoday!
It was not long ago that some worried that the recovery was losing steam. But the third quarter turned out to have decent growth and now the latest economic news for the fourth quarter suggests that momentum is building—although one still cannot describe growth as robust.
 Equities ended the week with the Dow and S&P500 at two year highs while the Nasdaq hit a three year high.
Quite a few factors supported Monday. No key economic indicators posted in the U.S. on Monday but continued optimism that most of the tax cut deal between the Obama Administration and Congress will be enacted helped fuel moderate gains in indexes ahead of a key vote in the Senate on the package. With early gains only moderate, indexes fell back notably toward the end of trading, tugged down by retail and technology stocks.
Trading on Tuesday looked a lot like that on Monday. Stocks showed strength during most of the day only to give back gains during the last hour. Supporting indexes were a stronger than expected retail sales report for November and lower than projected business inventories, indicating that inventory restocking will continue to support the recovery. The Fed’s FOMC announcement was largely as expected.
Most indexes took a step back Wednesday as European debt concerns outweighed favorable economic news and progress on tax cut legislation. Manufacturing was stronger than expected with improvement in national industrial production for November and a rebound in the New York Fed’s Empire State manufacturing survey. But worries that Spain’s credit rating may be cut weighed on stocks. Also, a stronger dollar tugged down on commodities oriented stocks—including the oil patch.
On Thursday, stocks advanced on a dip in initial jobless claims, a boost in the Philly Fed manufacturing index, and a rebound in housing starts. At week end, a strong index of leading indicators boosted equities, offsetting worries over European sovereign debt. Overall, strong economic news outweighed other factors.
Equities were up this past week. The Dow was up 0.7 percent; the S&P 500, up 0.3 percent; the Nasdaq, up 0.2 percent; and the Russell 2000, up 0.3 percent.
For the year-to-date, major indexes are up as follows: the Dow, up 10.2 percent; the S&P 500, up 11.6 percent; the Nasdaq, up 16.5 percent; and the Russell 2000, up 24.6 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Despite sharp swings during the week, Treasury yields ended the week about where they started.
On Tuesday and Wednesday, rates bumped up on strong economic news, including retail sales, Empire State, and industrial production. Yields fell back on Thursday on traders seeing Treasuries as oversold. For both Thursday and Friday, flight to safety played a role in lowering rates on news that Moody’s may cut Greece’s bond rating and over worries for the same for Spain.
For this past week Treasury rates were little changed as follows: 3-month T-bill, down 1 basis point; the 2-year note, down 2 basis points; the 5-year note, down 2 basis points; the 7-year note, down 2 basis points; the 10-year bond, up 1 basis point; and the 30-year bond, unchanged.
 The spot price for West Texas Intermediate was relatively stable this past week with daily close in a range of roughly $87.70 to $88.49.
Prices are high compared to earlier this year when spot hit a recent low of $67.25 on May 25. They are quite elevated relative to prices at and even just below the $40 mark just under two years ago.
Net for the week, spot prices for West Texas Intermediate edged up 39 cents per barrel to settle at $88.02.
It was a good week for the economy as the consumer and manufacturing sectors improved and housing appears to have stabilized.
 The fourth quarter is getting an upgrade by economists and a moderately strong retail sector is a key reason. Retail sales for November came in much stronger than expected, but the component detail is a little complicated—at least in terms of price effects.
Overall retail sales in November posted a healthy 0.8 percent gain, following an upwardly revised 1.7 percent boost in October. Excluding autos, sales were even more robust with a 1.2 percent rise, following a 0.8 percent jump in October and coming in above analysts’ forecast for a 0.7 percent increase. Sales excluding autos and gasoline rose 0.8 percent, matching October’s advance.
For the latest month, overall sales were led by a 4.0 percent spike in gasoline station sales which likely was price related. Also likely suffering upward price pressure was a 0.8 percent rise in food & beverage store sales. Nonetheless, many other components were notably strong, including sporting goods & hobby, up 2.3 percent; clothing, up 2.7 percent; and general merchandise, up 1.3 percent. A standout weakness was in electronics & appliance stores, down 0.6 percent, and likely weak from discounting. So, not only were there price effects bumping sales up, but also some with a damping effect.
The bottom line is that retail sales have posted healthy gains for four consecutive months, moving past the soft patch at mid-year. The latest retail sales numbers should lead to upward revisions to forecasts for the PCEs component in fourth quarter GDP. Already, many economists have announced broad upward revisions to their growth forecasts for 2010 and 2011 due in no small part to the recent trend in consumer spending.
 Housing starts posted a nice comeback in November but off of a very weak level. And the composition was not what was expected. Housing starts in November rebounded 3.9 percent, following a sharp 11.1 percent drop the prior month. The November annualized pace of 0.555 million units is down 5.8 percent on a year-ago basis.
 In October, the multifamily component had fallen sharply and analysts had expected that component to lead a November rebound in overall starts. Instead, the gain in November was led by a monthly 6.9 percent boost in single-family starts, following a 2.7 percent dip the month before. November’s single-family pace of 0.465 million units was the highest level since the 0.563 million for April 2010. The multifamily component actually pulled down on the overall number, falling another 9.1 percent after plunging 35.7 percent in October.
Overall permits, however, fell back 4.0 percent in November after edging up 0.9 percent in October. Permits came in at an annualized rate of 0.530 million units and are down 14.7 percent on a year-ago basis. The latest decline was led by the multifamily component which was down a hefty 23.0 percent while single-family permits improved 3.0 percent.
There is still downward pressure on starts from supply overhang. New single-family homes still had an 8.6 months supply of homes for sale in October. Homebuilders are not seeing improvement in sales activity as the National Association of Homebuilders’ housing market index at 16 for December was still only modestly above the series low of 8 set in January 2009.
Basically, housing is not getting worse—but there is not much improvement either. Looking ahead, not much can be read into the dip in housing permits as the multifamily component is lumpy and volatile on a monthly basis. Until home sales pick up along with household formation (which depends on job growth), starts are going to remain sluggish. But again, the good news is that at least housing appears to have stabilized.
 Earlier released source data sometimes give a good warning for an indicator and sometimes not. This time, for manufacturing output, it was not. The Federal Reserve Board uses parts of the BLS data on aggregate production hours for its initial estimate of the manufacturing component of industrial production. Production hours based initial estimates are later replaced with hard data. For November, manufacturing production hours slipped 0.1 percent. So, it was a nice surprise that manufacturing actually posted a moderate gain.
Headline production improved on a rebound in utilities output and manufacturing was stronger than expected. Overall production improved in November, rising 0.4 percent, following a revised 0.2 percent dip the month before. By major components, manufacturing gained 0.3 percent, matching the boost in October. For other major industry groups, utilities output rebounded 1.9 percent after dropping 3.7 percent in October. Mining edged down 0.1 percent, following a 0.2 percent decline the month before.
 Within manufacturing, gains were broad based. The output of durable goods rose 0.4 percent, and with the exceptions of nonmetallic mineral products and motor vehicles and parts, output advanced in all of the major industries. The production of nondurable goods rose 0.2 percent.
Motor vehicle assemblies actually held manufacturing back in the latest month. Output of motor vehicles and parts fell 6.0 percent, after rising 1.5 percent in October. Excluding motor vehicles, manufacturing actually posted a robust 0.7 percent boost, following a 0.2 percent advance the prior month.
Capacity utilization firmed to 75.2 percent in November from 74.9 percent in October. Capacity utilization is at its highest since a reading of 75.4 for October 2008.
The good news is that manufacturing has regained some of it momentum over the last two months. Early indications for December manufacturing are mostly positive.
 With the latest two regional readings on manufacturing, the net outcome suggests that this sector is regaining some momentum. The New York Fed’s Empire State manufacturing report showed a sizeable rebound in its headline index for general business conditions which jumped to plus 10.57 in December from minus 11.14 in November, meaning overall conditions swung from contraction to moderate growth. New orders improved to plus 2.60 in December from minus 24.38 the prior month. However, the latest reading indicates marginal growth only as it is barely above breakeven. There was a mild contraction in the employment index.
 But there is even more broad based improvement in the Philly Fed report as manufacturing activity picked up this month in the Mid-Atlantic region. The Philly Fed’s general business activity index rose nearly two points to 24.3.
Specific readings on new orders and backlog orders are both picking up steam which is good news for future shipments and employment. The new orders index advanced to 14.6 from 10.4 in November. Manufacturers in the sample added to their workforces though, like shipments, at a slower pace than in November. They did, however, sharply extend the workweek, that is they worked their existing workforce longer, suggesting a possible boost in hiring in the near term.
Overall, manufacturing appears to be improving in December, adding to momentum for the recovery.
 We are seeing a lot of inflation in commodities—including oil—and in production costs for food. But so far, it has not reached the consumer for the most part. That is, the CPI was a little tamer than expected for November as food and energy were not as strong as feared and prices were pervasively soft elsewhere. The overall CPI in November rose a modest 0.1 percent, following a 0.2 percent increase in October. Excluding food and energy, CPI inflation firmed to up 0.1 percent from no change the month before.
 Many economists had expected the energy component to boost the headline number due to the recent surge in crude oil prices. But energy was relatively tame, thanks to a drop in natural gas prices. Energy increased only 0.2 percent, following a 2.6 percent surge in October. Most of the November rise was from fuel oil which jumped 4.2 percent. Gasoline was up 0.7 percent while electricity rose 0.9 percent. Damping these was a 5.7 percent drop in natural gas costs. And Food was relatively tame, rising 0.2 percent after a 0.1 percent rise the prior month.
For the 0.1 percent gain in the core, increases in the indexes for shelter and airline fares accounted for most of the rise, while the indexes for new vehicles, used cars and trucks, and household furnishings and operations all declined. Softness was widespread within major expenditure components.
Year-on-year, overall CPI inflation rose to 1.1 (seasonally adjusted), down from 1.2 percent in November. The core rate in firmed to 0.7 percent from 0.6 percent in October. On an unadjusted year-ago basis, the headline number was up 1.1 percent in November while the core was up 0.8 percent.
The bottom line is that inflation at the consumer level is still quite subdued despite inflation pressure beginning to rise at the producer level and already high for commodities. The November CPI allows or rather calls for the Fed to continue with balance sheet expansion. However, inflation is lurking further upstream in earlier stages of production.
 While inflation is still subdued at the consumer level, headline has picked up at the producer level.
The overall PPI inflation rate for finished goods jumped to a monthly 0.8 percent increase from a 0.4 percent pace in October. The headline PPI has risen by at least 0.4 percent for four consecutive months.
At the core level, the November PPI rebounded 0.3 percent after dropping 0.6 percent the month before.
 For the latest month, food prices rose 1.0 percent after slipping 0.1 percent in October. The energy component rose another 2.1 percent, following a 3.7 percent surge in October. Within energy, gasoline surged 4.7 percent, following a monthly 9.8 percent spike in October. The core was boosted in part by a 1.7 percent increase in passenger car prices after a 3.0 percent dip in October.
The recent uptrend in overall PPI finished goods inflation is not yet showing up in year-ago numbers due to softness during spring of this year still in the 12-month percent change. For the overall PPI, the year-on-year rate decreased to 3.5 percent from 4.3 percent in October (seasonally adjusted). The core rate eased to 1.3 percent from 1.4 the prior month.
Inflation is even stronger for earlier stages of production. Intermediate goods prices rose 1.1 percent in November while crude goods gained 0.6 percent. For intermediate goods, the November advance was broad-based, with prices for intermediate energy goods rising 2.8 percent, the index for intermediate materials less foods and energy increasing 0.7 percent, and prices for intermediate foods and feeds climbing 1.9 percent. For crude goods, leading the monthly November rise was crude nonfood materials less energy, up 3.1 percent, and also foodstuffs and feedstuffs, up 0.7 percent.
On a year-ago basis, intermediate is up 6.3 percent (not seasonally adjusted) while crude is up 12.8 percent.
Inflation at the producer level is picking up—especially for food and energy. While pass through has been limited, more of the cost increases could be seen soon at the consumer level.
 There has been a lot of talk by economists that economic indicator news in recent weeks shows a definite gaining in momentum, albeit still in the moderate range of growth. The latest reading for the Conference Board’s index of leading indicators paints a relatively concise picture of this momentum building continuing with the November index jumping 1.1 percent, following healthy gains of 0.4 percent in October and 0.6 percent in September.
In addition to the sharp rise, what also stands out for November is that the boost was based on widespread positive contributions by components with all but one contributing to the November gain. Leading the way was supplier deliveries which added 0.43 percentage points, followed by the rate spread between 10-year Treasuries and fed funds adding 0.27 percentage points. Also adding to November’s boost were the average workweek in manufacturing, initial jobless claims, new orders for consumer goods & materials, new orders for nondefense capital goods, stock prices, money supply, and consumer expectations.
Several components for December already appear to be lining up for the plus column. Given the jump the last two weeks in the 10-year Treasury yield, December's spread appears certain to widen. Jobless claims so far are down in December. And stock prices are up.
 At its December 14 policy meeting, the Fed left policy rates unchanged with the fed funds target rate still at a range of zero to 0.25 percent and left intact plans for further balance sheet expansion.
Regarding its evaluation of the economic, the meeting statement said that the recovery is "continuing, though at a rate that has been insufficient to bring down unemployment."
Once again, the Fed kept language that the target rate is likely to be exceptionally low for an extended period.
Regarding its two policy objectives (employment growth and stable inflation), the Fed sees that there still is work to do.
"Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward."
"Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow."
Basically, the Fed still sees the need to continue with its plans for balance sheet expansion. In turn, the Fed maintained its position regarding continuing with $600 billion in QE2.
"To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month."
Kansas City Fed President Thomas Hoenig continued to dissent.
The bottom line is that QE2 continues much as expected. This will continue to support economic recovery, eventual lower unemployment, and a more acceptable rate of inflation. However, the biggest criticism of the latest FOMC statement is that the Fed likely was too negative in its evaluation of the economy, given the recent string of economic news that has been mostly positive and exceeding expectations.
The vast majority of economic news indicates that economic growth is stronger in the fourth quarter than in the third. Although the recovery is still below par, it is gaining traction and additional stimulus from tax cuts (beyond maintaining income tax rates that were to expire this year) and from QE2 should help momentum continue to build gradually.
As markets prepare for holiday close, we also see a close to estimates for third quarter GDP on Wednesday. Durables orders on Thursday will give insight on whether manufacturing is regaining strength. The consumer sector gets updates the same day with personal income and with consumer sentiment. Finally, homebuilders check on demand with existing and new home sales out Wednesday and Thursday, respectively.
GDP growth for the third quarter GDP growth was revised up to 2.5 percent annualized growth in the November release from the advance estimate of 2.0 percent. Final sales of domestic product were boosted to 1.2 percent from the initial estimate of 0.6 percent. Final sales to domestic purchasers were bumped up to 2.9 percent from the original figure of 2.5 percent for the third quarter. Importantly, PCEs growth was a stronger 2.8 percent, compared to the advance estimate of 2.6 percent. On the inflation front, the GDP price index was unchanged from the initial estimate of 2.3 percent. The consensus forecast was for 2.3 percent.
Real GDP Consensus Forecast for third estimate Q3 10: +3.0 percent annual rate
Range: +2.3 to +3.1 percent annual rate
GDP price index Consensus Forecast for third estimate Q3 10: +2.3 percent annual rate
Range: +2.2 to +2.6 percent annual rate
Existing home sales fell 2.2 percent in October to a 4.43 million annual unit rate. Most of the indications in this report were weak including low to mid-single digit declines across regions and for both single-family homes and condos. Supply on the market is very heavy at 10.5 months.
Existing home sales Consensus Forecast for November 10: 4.75 million-unit rate
Range: 4.25 to 4.99 million-unit rate
Durable goods orders in October fell a revised 3.3 percent (originally down 3.4 percent), following a 5.0 percent spike the month before. Weakness was broad based but led by transportation. Excluding transportation, durables declined 2.7 percent after rising 1.3 percent in September. Transportation fell 5.2 percent in October after surging 16.5 percent the month before. The drop was mainly in defense aircraft but nondefense aircraft and also motor vehicles orders eased. Other industries generally declined but mostly after a moderate gain in September. More recently, the ISM durables orders index for November remained positive but slowed from 58.9 in October to 56.6. For regional surveys, the Philly Fed durables orders index swung sharply into positive territory while Empire State’s comparable index dropped into negative territory from positive.
New orders for durable goods Consensus Forecast for November 10: -1.0 percent
Range: -3.6 percent to +2.5 percent
Personal income in October posted a healthy 0.5 percent gain, following no change in September. Importantly, the wages & salaries component jumped 0.6 percent, following a 0.1 percent improvement the month before. Household spending also showed strength. Personal consumption expenditures rose 0.4 percent, following a 0.3 percent increase in September. The PCE price index increased 0.2 percent in October, following a 0.1 percent uptick in September. The core rate was flat for the second month in row. Looking ahead, the wages & salaries component in personal income for November is likely to pull back a little as aggregate earnings slipped 0.2 for the month. On the spending side, there should be a moderately strong gain in PCEs for November despite a flat number for unit new motor vehicle sales. Nonauto retail jumped 1.2 percent for the month. Meanwhile, PCE inflation should remain soft as both the headline and core CPI rose only 0.1 percent in November.
Personal income Consensus Forecast for November 10: +0.2 percent
Range: +0.1 to +0.3 percent
Personal consumption expenditures Consensus Forecast for November 10: +0.5 percent
Range: +0.4 to +0.8 percent
Core PCE price index Consensus Forecast for November 10: +0.1 percent
Range: +0.1 to +0.2 percent
Initial jobless claims for the December 11 week eased 3.000 to 420,000. This extends a run of improvement evidenced by the four-week average which has fallen for six weeks in a row. The average, at 422,750, is down more than 20,000 from a month ago in what is a positive signal for payroll growth.
Jobless Claims Consensus Forecast for 12/18/10: 420,000
Range: 400,000 to 425,000
The Reuter's/University of Michigan's Consumer sentiment index based on the early December sample, the preliminary sentiment reading for December advanced to 74.2 from the final November figure of 71.6. December’s initial number is above the implied figure for second half November of 73.9. So, we have seen steady progress in sentiment since early October’s reading of 67.7. By components, current conditions and expectations improved by 3.6 points and 2.0 points, respectively. The consumers' view of current conditions remains notably more favorable that for expectations. Whether there is further advancement for the final December reading is a tough call. Initial jobless claims have been on a downtrend but hiring is not picking up much. Also, gasoline prices are up significantly.
Consumer sentiment Consensus Forecast for final December 10: 75.0
Range: 73.0 to 76.0
New home sales in October fell 8.1 percent to 283,000 units annualized, nearly reversing the prior month's 12.0 percent rebound. The breakdown shows major declines in the West, Midwest, and Northeast that far outweigh a solid gain in the South. The drop in sales inflated supply to 8.6 months from 7.9 months. Supply is heavy not because of the number of new homes on the market, which at 202,000 is the lowest in 42 years, but because there are so few buyers.
New home sales Consensus Forecast for December 10: 300 thousand-unit annual rate
Range: 290 thousand to 320 thousand-unit annual rate
SIFMA Recommended Early Close 2:00 ET
U.S. Holiday: Christmas Day Observed
All Markets Closed, Banks Open
The year closes with updates for the consumer sector with consumer confidence posting Tuesday and jobless claims Thursday. An early indicator for housing demand, pending home sales, prints Thursday. The same day we get an early warning for manufacturing and nonmanufacturing surveys with the Chicago PMI.
The Conference Board's consumer confidence index improved in November, rising more than four points to 54.1 led by gains in the expectations component, the leading component that points to overall improvement in future months. The assessment of the current situation improved but only marginally. The lack of meaningful improvement in the current situation reflects frustration over jobs. Those saying jobs are hard to get inched yet higher to 46.5 percent. Those saying jobs are plentiful rose a half percentage point to a still miniscule 4.0 percent.
Consensus forecasts not yet available
Initial jobless claims for the week ending December 25, 2010 will be posted.
Consensus forecasts not yet available
The Chicago PMI strengthened in November to 62.5 from 60.6 the prior month. The composite has come in above 60 for three months in a row. Production, at 71.3, is humming and is raising demand for employment which is at 56.3 compared to October's also strong 54.6. Looking ahead, December’s composite should be healthy as the new orders index in November rose to 67.2 from 65.0 the prior month.
Consensus forecasts not yet available
The pending home sales index jumped 10.4 percent in October, following a 1.8 percent dip the month before. Pending home sales have risen in three of the last four months. But other measures of home sales have been volatile and showed slippage—including the latest reading of existing home sales and new home sales.
SIFMA Recommended Early Close 2:00 ET
R. Mark Rogers is the author of The Complete Idiot’s Guide to Economic Indicators, Penguin Books, October 2009.
Econoday Senior Writer Mark Pender contributed to this article.
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