TGIF Econoday Simply Economics 4/10/00 By Evelina M. Tainer, Chief Economist

Daily averages mask week’s roller coaster
How does one describe a week when each day is a story in itself? The basis of the story has its roots in 1999. After all, when a market index surges 85.6 percent in one year – how can you not expect some offset? Market pundits have indicated that the overvaluation in the technology sector was bound to adjust eventually. Instead, the NASDAQ composite index simply surged ever forward in 2000. But seeds of doubt were sown early in the year when the high tech market tumbled in mid-January. Over a week ago, market maven Abby Joseph Cohen provided a trigger for some additional selling when she downgraded her technology weighting and her asset allocation for stocks. This past week, many analysts viewed the government’s anti-trust decision against Microsoft as a trigger for a sell off in the tech area, despite the plausible notion that a Microsoft break-up would increase competition and fuel other tech stocks to greater heights. In a volatile and overvalued market, just about any excuse is a trigger point. A more realistic reason for the market volatility may be the high degree of margin lending. All of the major brokerage firms noted that margin calls were up dramatically on Tuesday, which did exacerbate market activity.

The dramatic backpedaling in the high tech sector led to some forward momentum in the old blue chips. The Dow surged early in the week moving exactly in the opposite direction of the NASDAQ. The plunge in the high tech sector coupled with a surge in the Dow on Monday helped to narrow the differential between these two indices that had widened to unprecedented levels in February and early March. During the rest of the week, the Dow patterned itself after the high tech index, even on Wild Tuesday when they both dropped more than 500 points only to claw their way back to more neutral territory.

The S&P 500 pretty much mirrored the Dow Jones Industrials this past week. It continues to outperform the Dow and remains above year ago levels. The Russell 2000, measuring the small cap sector, has moved in tandem with the NASDAQ composite index since many of the larger companies in the index are in the high tech sector.

Treasury Rally across the curve - doesn't help mortgage market
Treasury securities generally rallied this past week. Yields were lower across the board. Earlier in the week, though, the market also saw some improvement in the spreads. By week’s end, rumors that long bond issuance would be eliminated pushed yields on the 30-year down more dramatically than other securities. As a result, the inversion of the yield curve slid further into negative territory.

While Treasury securities are rallying in a big way, rates in the mortgage market have remained quite stable these past several weeks. In the past, mortgage rates have closely followed yields on 10-year Treasury notes. This relationship has deteriorated in the past two months when supply concerns hit the Treasury market. While this hurts consumers – and helps fatten profit margins for mortgage companies – it may relieve Fed officials that the Treasury isn’t undoing all its hard work of tightening credit conditions. Indeed, if mortgage rates were more in line with historical relationships to the Treasury yield, the Fed would probably have to raise rates by about 75 basis points more than it already has!

 

Markets at a Glance
Treasury Securities	12/31/99	Mar 31	Apr 7	Weekly Change
30-year Bond	6.48%	5.83%	5.71%	- 12 BP
10-year Note	6.43%	6.01%	5.85%	- 16 BP
5-year Note	6.34%	6.32%	6.19%	- 13 BP
2-year Note	6.24%	6.48%	6.36%	- 12 BP
Stock Prices
DJIA	11497*	10922*	11111*	+ 1.7 %
S&P 500	1469*	1499*	1516*	+ 1.1 %
NASDAQ Composite	4069*	4573*	4446*	- 2.8 %
Russell 2000	505*	539*	543*	+ 0.7 %
Exchange Rates
Euro/$	1.0008	0.9564	0.9545	- 0.2 %
Yen/$	102.40	102.71	105.38	+ 2.6 %
Commodity Prices
Crude Oil ($/barrel)	$25.60	$26.80	$24.85	- 7.3%
Gold ($/ounce)	$289.60	$281.60	$282.60	+ 0.4%
(BP = basis points; stock price indices are rounded)

Payrolls jump but underlying data reflect stability
Nonfarm payroll employment jumped 416,000 in March after a downward revised gain of 7,000 in February. Generally, the weak February payroll figure was supposed to be an offset to strong January numbers boosted by warmer-than-seasonal weather. Can we find some special factors in the March report to downplay the strength? We sure can! First and foremost, hiring for the 2000 Census boosted March payrolls by the tune of 117,000. Census hiring could add to payrolls for a couple more months. Eventually, the payroll data will go into reverse later this year as these temporary workers are laid off when the Census taking is completed.

March also saw an unusual occurrence that tends to happen every 28 years on the calendar. Five weeks, rather than the normal four, elapsed between survey periods. This isn’t uncommon in other months of the year, but doesn’t typically happen between February and March. Normally, the Bureau of Labor Statistics is able to adjust for five-week survey periods based on historical patterns, but that wasn’t the case this month. As a result, the five-week survey period had the effect of boosting payrolls anywhere from 50,000 to 100,000 in the month. Finally, 15,000 Boeing workers returned to the job after being on strike last month. After all is said and done, it does appear that the robust gain of 416,000 is diminished by nearly 200,000 and brings the monthly payroll increase back in line with average gains.

The chart below depicts average monthly gains on a quarterly basis over the past few years. Note that the first quarter average is nearly the same as the strong fourth quarter pace. Even though we can downplay the strength of the payroll numbers due to special factors, it doesn’t mean that economic activity won’t be robust for the period. While it may not necessarily lead to another real GDP growth rate of 7.3 percent, the first quarter growth will no doubt be in excess of the Fed’s preferred growth path of 3 to 3.5 percent.

The civilian unemployment rate remained unchanged in March at 4.1 percent. The household survey showed that both the labor force and measured employment declined for the month. While this is somewhat at odds with the payroll figures, it isn’t unusual to see such divergence from time to time. The pool of available workers – an indicator favored by Mr. Alan Greenspan himself – increased for the second straight month and now stands at the highest level since last August. This should reassure the Fed chairman that the labor supply is not diminishing at an accelerating rate.

Average hourly earnings rose 0.4 percent for the fourth straight month after posting smaller gains at the end of last year. This pushes up the year-over-year increase in earnings to 3.7 percent. While higher than the past few months, it is in line with increases seen since 1999 – and far from the peak reached in mid-1998. Nevertheless, Fed officials won’t like the growth path in wages even if it doesn’t necessarily reflect gains in excess of productivity.

The bottom-line on employment? The employment report is not as robust as indicated by the monthly payroll figures. Yet special factors can’t be removed from economic data month after month. At some point, special factors do add up to real changes in activity. And despite such factors boosting employment data in the first quarter, there is no question that these will add to economic growth in terms of real GDP growth for the period.

Federal Reserve officials attempt to adjust for special factors in making policy decisions. The March employment report is not likely to sway them to increase tightening measures. The gradual policy approach of raising the federal funds rate target by 25 basis point increments should remain intact over the next few months.

THE BOTTOM LINE
Economic indicators were generally not relevant this week as market players focused on actual and potential earnings in the equity market. Various triggers such as market guru Abby Cohen’s shift in outlook vis-à-vis technology stocks and the court’s decision on the Microsoft anti-trust case set in motion a dramatic roller coaster ride.<

In the bond market, investors also went on the same roller coaster as equities. Treasury securities are generally a safe-haven investment vehicle when uncertainty prevails. As investors dumped stocks during the week, Treasury securities benefited across the maturity spectrum. But the Treasury market is undergoing its own turmoil, feeling the impact of a diminishing borrowing schedule by the U.S. government.

The employment report wasn’t the first indicator of the week, but it was probably the only indicator of any importance to financial market players. Despite strong headline numbers, underlying data seemed to indicate that economic activity and inflation did not accelerate in March.

Based on the employment report, Fed officials are likely to continue their gradualist policy of raising the federal funds rate target by 25 basis points over the next couple of months.

Looking Ahead: Week of April 10 to April 14
Market News International compiles this market consensus which surveys about 20 economists each week.

Thursday
Market participants are expecting new jobless claims to rise 5,000 in the week ended April 8 from last week's 260,000 level.

The market consensus is looking for an increase of 0.5 percent in the PPI in March. In February, the PPI surged 1 percent. Higher energy prices will also contribute to the March PPI. Excluding food and energy, the PPI is expected to edge up a more modest 0.1 percent for the month, after gaining 0.3 percent in February.

Economists are predicting retail sales to increase a meager 0.2 percent in March after recording a stronger 1.1 percent hike in February. Excluding autos, retail sales are expected to rise 0.6 percent. The more sluggish March pace in retail spending stems from the fact that Easter is relatively late this year and is hampering seasonal adjustment factors.

Friday
Market players are looking for a 0.5 percent spurt in the CPI in March, after a larger 0.5 percent hike posted in the previous month. Gasoline prices jumped more than 12 percent during the month and played a major role in the gain. Excluding food and energy prices, the CPI should rise 0.2 percent, the same as the past couple of months.

Economists expect business inventories to rise 0.5 percent in February after a 0.5 percent gain in January. This incorporates actual data for manufacturing and wholesale trade; only retail trade inventories are still unavailable.

The index of industrial production is predicted to rise 0.2 percent in March, matching the February pace after more strength in January. This is based on the modest drop in factory payrolls. The capacity utilization rate should edge down to 81.6 from the previous month’s level of 81.7.