Consumers take breather Econoday Simply Economics 6/19/00 By Evelina M. Tainer, Chief Economist

Much ado about nothing
Once again, the weekly stock price movements can be summarized as mild this week – except for the sharp drop in the Dow Jones Industrials on Friday. Worries about bank stocks led the index down after Wachovia Bank warned that upcoming earnings would be weaker than expected. This hurt bank stocks in a big way on both Thursday and Friday. Otherwise, the Russell 2000 was the only major stock index to remain above year-end levels. The Dow and the NASDAQ composite are still six to ten percent under water for the year. The S&P 500 is only 0.3 percent below year-end levels.

Sluggish economic news leads to bond market rally
For the most part, economic news was weaker than expected – particularly those indicators related to the consumer. Between declines in retail sales and housing starts, bond investors were beginning to feel much more comfortable that the end of the tightening cycle may be in sight. Hawkish comments by Fed governors were practically ignored. By week’s end a sharp drop in the Dow also helped bond yields to rally.

 

Markets at a Glance
Treasury Securities	12/31/99	June 9	June 16	Weekly Change
30-year Bond	6.48%	5.90%	5.87%	- 3 BP
10-year Note	6.43%	6.13%	5.97%	- 16 BP
5-year Note	6.34%	6.36%	6.18%	- 18 BP
2-year Note	6.24%	6.55%	6.35%	- 20 BP
Stock Prices
DJIA	11497*	10614*	10449*	- 1.6 %
S&P 500	1469*	1457*	1464*	+ 0.5 %
NASDAQ Composite	4069*	3875*	3861*	- 0.4%
Russell 2000	505*	523*	514*	- 1.7 %
Exchange Rates
Euro/	1.0008	0.9530	0.9658	+ 1.3 %
Yen/	102.40	106.83	106.31	- 0.5 %
Commodity Prices
Crude Oil ($/barrel)	$25.60	$30.05	$32.35	+ 7.7 %
Gold ($/ounce)	$289.60	$286.50	$291.50	+ 1.7 %
(BP = basis points; stock price indices are rounded)

Housing starts and retail sales weaken
Housing starts fell 3.9 percent in May to a 1.592 million-unit rate. This was the third decline in starts in five months. Clearly, the chart below does reveal that housing starts peaked in February but have steadily dropped since. Townhouses and apartment buildings helped boost total construction in the past several months. The fact is that single-family housing starts peaked in December 1999 and are now at their lowest level since April 1999. Construction of large apartment complexes can skew the monthly data from time to time. There is no question that interest rate changes impact single family construction more dramatically and consistently. Fed officials were anxious to see if the rate hikes of the past year were causing housing demand to moderate. And in fact, the rate hikes are having the intended effect, just with a bit of a lag.

Retail sales dipped 0.3 percent in May after a downwardly revised drop of 0.6 percent in April. This was the first two-month decline in retail sales since July and August 1998. In both cases, declines in auto sales were a major factor behind the drop. Durable goods in general also recorded some weakness. For instance, sales at building materials and hardware stores fell in five of the past six months! This goes along with the downward trend in housing starts. Furniture and appliance store sales also dipped in May for the first time in six months. Higher interest rates typically hamper durable goods spending.

Retail sales of nondurable goods have also weakened considerably these past two months. Nondurables edged up 0.2 percent in May but edged down 0.1 percent in April. A plunge in sales at gasoline service stations dampened April sales, but so did a drop in apparel stores and restaurants. In May, restaurant sales fell again, and so did spending at grocery stores.

The bottom-line on the consumer? The retail sales chart above clearly depicts a decided moderation in the pace of consumer spending. One could say that a drop in auto sales overstates the weakness, but the three-month moving average of retail sales shows that the underlying trend is simply lower than it was several months ago. The Fed’s past six interest rate hikes are undoubtedly reducing housing demand, leading to weakness in durable goods such as furniture and appliances.

Higher energy prices have to be impacting consumer spending as well. When consumers spend a few cents more per gallon on their weekly fill-up, the extra money going to gasoline expenditures may not even be noticeable. It could be the cost of a coke or a candy bar. But gasoline prices have surged in the past couple of months. The money going to gas is tangible to consumers – who now have less discretionary income for movies, computer games, videos, music CDs, etc.

Fed officials certainly would never admit this, but higher energy prices are bound to choke off some consumer spending. In addition to higher rates and a rather sluggish stock market, energy prices may be cooling down the economy this summer. It is really debatable whether the Fed has completed its tightening rounds, but lower housing starts coupled with anemic retail sales could stay the Fed’s hand at the June 27 & 28 FOMC meeting.

Inflation is the name of the game
The consumer price index edged up 0.1 percent in May after remaining unchanged in April. Energy prices fell 1.9 percent for the second straight month. This was unusual – and indeed labeled as a timing anomaly by the Labor Department. They expect a spurt in energy prices to show up in June as an offset to the May drop. So be forewarned that the June CPI figure could be ugly. In May, the year-over-year rise edged up to 3.1 percent. Even after discounting the temporary blip from a few months ago, it does look like there is a slight upward trend in consumer price inflation.

Indeed, the CPI less food and energy prices increased 0.2 percent – in line with the gains of the past few months. But the year-over-year rise also edged higher in May to show a 2.4 percent rise. Yes, we’ve seen worse inflation in 1997 and 1998, but then it was heading down, not up like it is now.

The bottom-line on inflation? Most analysts, including Fed officials, view the consumer price index as a lagging indicator of inflation. That may well be the case, but the CPI data on its own doesn’t look favorable from the point of view of central bankers whose primary goal in life is to keep inflationary pressures at bay. At this point, the slowdown in demand will play a bigger role in the debate whether to raise rates or not at the June 27 & 28 meeting, but the CPI data still looms over the heads of Fed officials.

Surprise growth in production
The index of industrial production rose 0.4 percent in May after larger 0.7 percent gains in the previous two months. However, the figures were surprisingly strong since the consensus of economists was calling for a drop of this magnitude in the index, based on the employment report. Production of consumer goods and construction supplies did decline for the month. However, business equipment posted another healthy gain – bringing the year-over-year rise to up 8.7 percent. If the growth is coming from capital spending, that could help to boost productivity in the future.

The capacity utilization rate remained unchanged at 82.1 percent in May, but is significantly higher than a year ago. Nevertheless, the old rules of thumb suggest that inflationary pressures begin to develop after the operating rate hits 83 percent.

THE BOTTOM LINE
Market players were rewarded with plenty of economic data this week. Moreover, the bulk of the data suggested that economic activity might be starting to moderate. One month of weak figures doesn’t make a trend. But in the case of retail sales and housing starts, figures have weakened over the past several months. This should reassure Federal Reserve officials that consumer demand is indeed waning due to the rate hikes of the past year.

Despite the market-friendly data this past week, several Fed officials have pointedly commented that the economy and the potential for inflation remain strong. It is likely that the Fed tightening rounds may be paused, but aren’t yet complete. Market players are now centering on the view that the Fed won’t raise rates in June, but could possibly raise rates in August.

Looking Ahead: Week of June 19 to June 23
Market News International compiles this market consensus which surveys about 20 economists each week.

Tuesday
The consensus shows the international trade balance on goods and services is expected to narrow in April to reveal a shortfall of $29.3 billion compared with a $30.2 billion trade deficit in March. Economists are predicting small increases in exports and imports.

The federal budget is predicted to record a modest deficit of $2 billion in May, much smaller than the deficits recorded in the previous couple of years for the same month. For the fiscal year to date, this reflects a surplus of $122 billion compared with a surplus of less than $41 billion for the same period last year.

Thursday
Market participants are expecting new jobless claims to decrease 1,000 in the week ended June 17 from last week's 296,000 level. Claims are likely to be rather volatile in the next several weeks since summer factory shutdown schedules are not exact from year to year.