Inflation news is benign
The producer price index edged up 0.1 percent in February after gaining 1.1 percent in the first month of the year. Both food and energy prices rose more slowly in February than in January - although both posted moderately large gains. Excluding these two volatile components, the PPI decreased 0.3 percent. This was indeed unexpected, reversing half of the 0.7 percent spurt posted in January. Over the two months, core inflation averaged a monthly gain of 0.2 percent. This is certainly more hopeful than the January scare.

In February, a good chunk of the drop in the core PPI came from declines in auto and truck prices. This more than reversed the January gain. It also is strong evidence that the laws of supply and demand really do work. Automakers are very quick to announce special rebates or price declines when they have over-built inventories and the demand for cars and trucks has fallen off.

It doesn't appear that inflationary pressures are building in the pipeline either. The intermediate goods price index edged up 0.1 percent in February after a 0.7 percent January spurt (due to oil). Excluding food and energy prices, the intermediate PPI inched up 0.1 percent in February - after similar gains in the past few months.

The PPI for crude materials plunged 14.2 percent in February, more than reversing the previous month's gain of 13.9 percent. Even excluding the volatile food and energy components, this index fell 2.5 percent during the month. To some extent, this is in line with the daily CRB index, which has posted dramatic declines these past several days. Commodity prices tend to react more quickly to economic activity than prices of finished goods (and services).

All in all, the PPI figures are certainly friendly news for the financial markets. The February moderation pretty much reveals that the January spike was a fluke and not indicative of a new upward inflationary spiral. This will certainly help Fed officials in their policy-making deliberations. Given that inflation is not a problem, it gives them more leeway in easing credit conditions and reducing the federal funds rate target.

Manufacturing sector still in the dumps
The index of industrial production fell 0.6 percent in February for the second month in a row and is down for the fifth straight month. The index stands a mere 1.2 percent above year ago levels. It matches the sharp downdraft in the capacity utilization rate, which declined to 79.4 percent in February. All major product groups posted declines in February. Ironically, construction supplies decreased the most (-0.9 percent) for the month. This is surprising given that housing starts have maintained a relatively high level of activity. This could very well suggest that orders are drying up and housing starts have yet to begin their descent. On a year-over-year basis, consumer goods and construction supplies are posting declines. Production of business equipment fell in the past few months, but is still up 6 percent from year ago levels.

Among the major industry groups, manufacturing fell 0.4 percent while mining declined 0.5 percent in February. Utilities dropped 2.3 percent in February on top of a 3.3 percent drop in January, but haven't erased December's 6.4 percent surge!

In the business equipment component, information processing remains a robust component. Production of information processing is up 3.5 percent between October 2000 and February 2001. In contrast, production of total business equipment is down 0.9 percent over the same period. Thus, high tech industries may be suffering, but other sectors are being hit harder!

Business inventories are reported with a longer lag time than production. The latest figures for January revealed that inventories were still growing in January even as sales were flat. This boosted the inventory-to-sales ratio. In an environment of falling demand, this suggests that the inventory build-up was not planned or desired. This signals that industrial production may be declining for a few more months yet.

The sluggish pace of activity here, even if it is concentrated in one sector, has to worry Federal Reserve officials. But the plunge in the stock market aside, it remains to be seen whether these figures are anemic enough (by Fed standards) to provoke a 50 basis point cut or a 75 basis point reduction in the federal funds rate target.

Housing starts
Housing starts edged down 0.4 percent in February to a 1.647 million-unit rate after jumping 4.8 percent in January. Whenever weather is warm in winter months such as January and February, housing construction can increase a bit, but the seasonal factor will make the seasonally adjusted figure appear much larger. Despite the two-month increase, housing starts were still 9.6 percent below year ago levels. Single-family housing starts declined 2.4 percent in February to a 1.315 million-unit rate. This was the first drop in single-family housing construction after four straight monthly gains.

So what can we say about the housing market? After all, the headline figures are somewhat of a mixed bag. There are really two ways of looking at these figures. On the one hand, the overall level of housing activity is relatively strong, particularly when one considers that the manufacturing sector is in recession and consumer optimism has diminished dramatically in the past several months. Housing starts are very sensitive to interest rates. Note how far mortgage rates have dropped in the past nine months. No wonder that housing activity improved in the second half of 2000 and early 2001.

On the other hand, single-family housing construction did show a marked decline in February. This could be signaling the beginning of a slowdown, one not due to interest rates but to slower income growth. The recent strength in housing starts could boost furniture and appliance sales, but not to the same extent as a year ago. As a result, the housing market is not likely to spark any burst of retail spending.

Retail sales dip
Retail sales fell 0.2 percent in February after an upwardly revised gain of 1.3 percent in January. Sales at durable goods stores edged down marginally but sales at nondurable goods retailers declined 0.3 percent in February. Excluding the volatile auto group, retail sales declined 0.3 percent for the month. As indicated in the chart below, the three-month moving average for retail sales improved in the past couple of months. Nevertheless, the trend for retail sales remains rather anemic compared with sales growth recorded in 1999.

Consumer confidence has tumbled the past several months. This has caused concern among Fed officials that consumer spending will follow suit. Thus far, the drop in consumer sentiment is more concentrated on future expectations than current conditions. Indeed, retail sales would be much weaker if there were a direct monthly correlation between spending and confidence. Nevertheless, the dramatic decline in consumer confidence could potentially translate into weaker retail spending in the next few months. The University of Michigan's consumer sentiment index in mid-March actually inched up to 91.8 from 90.6. But this uptick is meaningless from a statistical perspective. It still shows that consumers are more pessimistic about the economy now than they were just six months ago.