Leading with the good news
Housing starts surged 13.3 percent in September to a 1.843 million-unit rate after edging down over the past three months. A whopping 18.2 percent gain in single-family homes accounted for the total rise in housing starts; multi-family construction was down moderately for the month. Total housing starts were last seen at this lofty level in June 1986. One must go even further back in history - November 1978 - to see a larger rise in single-family construction.

Notice that the monthly volatility in housing construction appears to have increased this year with larger gains and declines from one month to the next. It makes more sense to look at the trends in housing rather than any one-month's level. In fact, the quarterly housing pace was stronger in the third quarter than in the second but not as robust as the first quarter of this year. This could mean that residential investment will lend a helping hand to boost GDP growth in the third and fourth quarters of the year.

There is no doubt that the falling level of mortgage rates has spurred housing activity this year. In July, 30-year fixed mortgage rates averaged 6.09 percent. The first three weeks of October show a slight dip to 6.05 percent. Mortgage rates, tied to yields on 10-year Treasury notes, have not come down as much as expected as lenders have maintained a wider gap than normal. It turns out that many lenders are overwhelmed with refinancing activity and must push back business by keeping rates firm.

Homeowners continue to refinance their loans at a heady pace. The recent drop in rates has made it favorable for homeowners to refinance mortgage loans that were closed a mere year ago at 7 percent or so. While a one percentage point reduction might not make refinancing worthwhile for someone who plans to eventually move, it might make financial sense for those who plan to stay put. Furthermore, the rapid home-price appreciation is giving homeowners increased equity that may be used to finance other bills. While some credit card companies have offered 0% financing incentives for six or nine months, interest rates on credit cards remain exceptionally high - more than 13 percent as estimated by the Federal Reserve Board last month.

In the meantime, the healthy pace of home construction should spur demand for furniture and home appliances over the next few months.

Inflation remains tame
The consumer price index rose 0.2 percent in September, less than the 0.3 percent gain posted last month. Energy prices increased 0.7 percent, although food prices rose more modestly. Excluding food and energy, the CPI inched up 0.1 percent in September, a smaller rise than the two previous months. As a result, the total CPI is up 1.5 percent from a year ago, while the core CPI is 2.2 percent higher than last September. Incidentally, the gain in the core CPI is the smallest yearly rise since February 2000. While prices of services are up 3.2 percent from a year ago, commodity prices are 0.9 percent below last year's levels. Inflation prospects remain favorable over the next several months.

Production: bad news bears
The index of industrial production edged down 0.1 percent in September after a 0.3 percent drop in August. Despite the two-month drop, industrial production still managed to rise at a 3.6 percent rate in the third quarter. Among major product groups, construction supplies grew 0.3 percent in September, after a 0.9 percent gain in August. Business equipment fell 1.7 percent in September and even consumer goods production dipped 0.1 percent for the month. A drop in auto and truck assemblies dampened business and consumer goods production in both August and September. On the plus side, selected high tech industries continued to gain ground, posting a 1.1 percent rise in September.

The outlook for October is not good. The Philadelphia Fed's business outlook survey plunged in October to -13.1 from an already anemic level of +2.3 in September. The chart below shows the strong positive relationship between the levels of the business outlook survey and the monthly change in the index of industrial production. Based solely on the information provided by this survey, one could predict a monthly drop of nearly 0.5 percent in October industrial production.

It is important to keep in mind that industrial production was hampered during the month because of the West Coast longshoremen lockout. Just-in-time inventories help to reduce inventory costs for many producers, but it means that any disruption to transportation will quickly be translated into slower production or outright stoppage.

International trade gap widens
The international trade deficit on goods and services widened sharply to a level of $38.5 billion in August after registering a shortfall of $35.1 billion in July. After increasing for five straight months, exports declined 1.3 percent in August. At the same time, imports jumped 2 percent, the seventh gain in eight months. Many analysts believe that importers, getting ready for the Fall shopping season, were anticipating a strike by West Coast longshoremen (who have been operating without contract since July 1).

Before the lockout shut down ports for 12 days, activity on the West Coast was not operating at full capacity. Massive bottlenecks developed. It is likely that trade distortions will be evident in the international trade statistics for a few more months. Since the trade figures are reported with a two-month lag, expect to see peculiar data through the end of this year at least. Keep in mind that the quarterly trade deficits could play havoc with the GDP data in the third and fourth quarters.

Job situation not improving
New weekly jobless claims jumped 22,000 in the week ended Oct. 12 to a level of 411,000, above the 400,000 mark that is considered a breakeven point for employment gains. As we start the Fall holiday season, weekly claims figures will be more volatile than usual since it is difficult to adjust for seasonal variation. It will be more important than ever to look at trends rather than one-week changes.