Inflation in check
The consumer price index fell 0.3 percent in July, more than reversing the 0.2 percent gain in June. The decline was the largest since April 1986 when energy prices were also pushing down the overall price index. Energy prices dropped 5.6 percent in July after a more modest decline of 0.9 percent in June. OPEC has already announced production cuts and crude oil prices have backed up again, but it is unlikely that energy prices will surge to the same extent they did in the past few years. Due to the July decline in the CPI, the year-over-year rise in consumer prices fell back to 2.7 percent after rising 3.3 percent in June.

Market analysts and investors have been taught to follow the core CPI, excluding food and energy prices, which offers less volatile month-to-month data. This index inched 0.2 percent higher, in line with the past few months. The yearly rise remained at 2.7 percent. While the overall CPI has shown marked improvement over the past year, the core CPI has drifted slightly higher - with roughly a 2.5 percent average yearly rise compared with a 2 percent trend in 1999. But it appears that the upward drift may be coming to an end. This should reassure Fed officials and investors because it will allow the Fed to concentrate on economic growth without fear of sparking inflation.

Housing activity still in high gear
Housing starts rose 2.8 percent in July to a 1.672 million-unit rate. Levels for the previous two months were revised down slightly. Nonetheless, housing starts are up a whopping 13.2 percent versus year ago levels. Starts of single-family homes (considered more sensitive to changes in interest rates and consumer incomes) rose 1.5 percent in July after remaining unchanged in June. Single-family home construction is up 13.6 percent from a year ago! But then consider that mortgage rates are 100 basis points lower than they were last July.

Some analysts are starting to predict that housing starts will embark on a downward trend soon since permits fell 1.8 percent in July and 2.1 percent in June. Perhaps, but we have found that permits are not as good of a leading indicator for housing starts as one would expect. However, if employment continues to decline in the next few months and disposable income softens, even lower mortgage rates won't spur housing activity very much.

Are consumers finally slowing down?
Retail sales were unchanged in July as they were in June. Excluding motor vehicles, retail sales inched up 0.2 percent just about offsetting the previous month's gain. There is no question that the May-to-July period was very soggy for retailers. Excluding gas stations, where price declines caused a drop in sales figures, retail sales show a somewhat improved picture. But there is no doubt that the trend has weakened considerably in the past year.

Given the strength in housing activity, one would expect some improved spending on furniture and home furnishings which should boost retail sales. Indeed, furniture sales have picked up in the past three months. But sales are down substantially on a year-over-year basis, and several furniture retailers have indicated that rising housing starts, unlike past experience, are not leading to increased spending on furniture.

Only a small portion of taxpayers received their rebate checks through July. It will be interesting to see whether retail sales will pick up in August and September, which also includes back-to-school sales. Some retailers are expressly targeting rebate spending by allowing consumers to cash their checks with their purchases at their stores. Perhaps this tactic will work. The University of Michigan's consumer sentiment survey showed an uptick at mid-month to 93.5 from 92.4 in July. But this is a small change and still puts confidence levels below those seen last January.

Autos boost industrial production
The index of industrial production fell 0.1 percent in July after declining 0.9 percent in June. The July drop was somewhat less than expected as auto and truck assemblies rose about 3 percent helping to boost production of consumer goods. Business equipment declined 0.3 percent and construction supplies fell 0.2 percent for the month. Aside from motor vehicles, clothing, and chemical products, weakness was prevalent in the production index. The high tech industry continued to suffer with another large drop.

Since industrial production fell less than expected (0.1 percent instead of the predicted 0.3 percent), market players concluded that the manufacturing recession might be coming to an end. But signs of weakness were rampant in the Philadelphia Fed's business outlook survey where the general conditions index declined to -23.5 in August from a level of -12.2 in July. Any level below zero means the manufacturing sector is contracting. In this case, the decline doubled between July and August. The Philly Fed's business outlook survey does a good job of predicting changes in the industrial production index. In this case, the August deterioration points to at least another sharp drop in production next month.

Foreign sector drag on industrial sector
The international trade deficit on goods and services widened slightly in June to $29.4 billion from a shortfall of $28.4 billion in May. The second quarter period showed an improvement from the first quarter and helped to lift real GDP growth for the period. However, continued declines in exports are certainly hurting the U.S. industrial sector. Exports of non-auto capital goods were down 11.2 percent in June relative to the year earlier period. Exports of non-auto consumer goods were 5 percent below year ago levels and auto exports were down 4.9 percent relative to last June.

The weakness in exports reflects the anemic pace of growth abroad which affects our production. The decline in imports reflects weakness in the United States. Total imports fell 0.7 percent in June after posting a 2.3 percent drop in May. The bulk of the weakness stems from a sharp slowdown in capital outlays. Imports of nonauto capital goods are down a whopping 16.5 percent from a year ago! Yet, imports of consumer goods are 0.9 percent higher than levels seen last June. While consumer spending has softened in the past year, it hasn't followed the same path as capital expenditures.