Market recovery begins? Econoday Simply Economics 4/24/00 By Evelina M. Tainer, Chief Economist

It’s a buying opportunity
After pondering through the weekend following the Friday collapse, equity investors must have figured it was a buying opportunity after all! Certainly some big names with actual earnings (and not just the promise of them in the year 2525) became worthwhile investments after their share prices were drawn, halved and quartered.

The funniest part of the week’s recovery was that stock investors seemed to come to the conclusion that the March CPI was just a one-month fluke. We did see a similar spurt last year and it was eventually reversed. The CPI might indeed be a one-time event. However, the strong retail sales figures are part of a long trend. Both these figures are going to play big roles in determining the Fed’s decision to raise rates 25 or 50 basis points at the next FOMC meeting in mid-May. As a result, the market’s dismissal of the CPI figures might be premature.

Treasury market: is it stocks or buybacks?
Treasury market players saw a lot of volatility this week. The reversal in the stock market on Monday led to a sharp rise in yields – particularly for the 30-year bond. So the safe-haven argument for holding Treasuries wasn’t particularly strong. Then bond investors ignored the stock market for a few days when the Treasury announced a new buyback operation. It turns out that the size of the buyback announcement was about half as much as expected. This disappointed market participants. By week’s end, yields had retreated slightly but were higher than last Friday in this holiday shortened week.

 

Markets at a Glance
Treasury Securities	12/31/99	April 14	April 20	Weekly Change
30-year Bond	6.48%	5.79%	5.83%	+ 4 BP
10-year Note	6.43%	5.90%	5.99%	+ 9 BP
5-year Note	6.34%	6.19%	6.24%	+ 5 BP
2-year Note	6.24%	6.34%	6.36%	+ 2 BP
Stock Prices
DJIA	11497*	10306*	10844*	+ 5.2 %
S&P 500	1469*	1357*	1435*	+ 5.7 %
NASDAQ Composite	4069*	3321*	3644*	+ 9.7 %
Russell 2000	505*	454*	482*	+ 6.2 %
Exchange Rates
Euro/$	1.0008	0.9623	0.9388	- 2.4 %
Yen/$	102.40	105.08	105.73	+ 0.6 %
Commodity Prices
Crude Oil ($/barrel)	$25.60	$25.40	$25.85	+ 1.8%
Gold ($/ounce)	$289.60	$284.80	$281.60	- 1.1%
(BP = basis points; stock price indices are rounded)

Housing starts plunge, but will sector continue to soften?
Housing starts dropped 11.2 percent in March to a 1.604 million unit rate. This was the lowest monthly pace since June 1999. Economists have been predicting a moderation in this sector for months as mortgage rates climbed. Yet, is this downdraft the start of a softening trend or just a one-month fluke?

As it turns out, new construction for multi-family units nose-dived 41 percent in March – more than reversing the 30.5 percent spurt reported in February. Starts decreased primarily in the Northeast and Midwest regions of the country. These are regions often affected by unseasonable weather. Moreover, it is easy to get big movements in this sector if just a single large apartment complex goes up in the winter time.

Construction of single family homes is less volatile over time and tends to be more sensitive to interest rate fluctuations. It also better reflects underlying consumer demand for new homes. Starts of single family homes remained unchanged in March from the February level. Both are down from the recent peak. Federal Reserve officials are quite concerned that current mortgage rate levels are not having much of a dampening effect on housing demand. Historically, interest rate hikes tend to curtail consumer spending first on such large ticket items as housing, furniture and autos. We haven’t seen anything yet.

The bottom-line on housing? Perhaps the slowdown in housing activity that economists have been predicting for the past couple of years is finally beginning. However, given the sharp variability of weather conditions, which affect housing activity more dramatically during winter months, one shouldn’t count on the March dip. Fed officials will be closely monitoring this data in coming months to see if mortgage rates will eventually curtail consumer demand.

Trade red ink widens
The international trade deficit on goods and services widened to $29.2 billion in February from a downward revised shortfall of $27.4 billion in January. Exports fell yet again, while imports rose 1.5 percent for the second straight month. Despite the rise in imports, the year-over-year gain may have stabilized a couple of months ago below its 19.2 percent peak. Exports are only rising 9.5 percent from year ago levels, but have showed improvement through the past year.

The bottom-line on foreign trade? The trade deficit widened because aircraft shipments from the U.S. fell off and oil imports surged. At least part of the rise in oil is due to higher prices. These two swing factors could shift direction in the next couple of months. That would boost total exports and at least moderate the growth in import demand.

The foreign trade deficit is not easily diagnosed. In the old days one would abhor the deficit, buying goods and services from foreigners and keeping wages from U.S. workers. On the other hand, the ability of purchasing cheaper foreign goods helps to hold down inflationary pressures. Furthermore, the tight labor markets in the United States, coupled with strong aggregate demand, has generated an even greater need for imports to satisfy U.S. businesses and consumers.

THE BOTTOM LINE
Federal Reserve officials probably watched the market volatility with as much fascination as market players this past week. Economic indicators were not decisive in giving Fed officials policy direction. Housing starts did cool off a bit in March, but the drop was concentrated in the notoriously volatile multi-family sector. It is too soon to tell whether housing activity will be softening in coming months. The trade deficit widened as import demand surpassed export demand again. This suggests partly that consumer and business demand is being satisfied by foreign production. However, special factors contributed to the shortfall, and these may be reversed in the next couple of months. In any case, the trade gap will certainly hold down GDP growth in the first quarter which ought to be favorable by Fed standards.

Last week’s market correction might have stalled the Fed’s policy actions in coming months. Certainly the CPI and retail sales figures favored a more aggressive approach to tightening (50 basis points rather than the normal 25 basis points increase on the federal funds rate). A market correction of the size we saw last week, if sustained, might have actually hampered consumer spending to some degree. And that would have reassured Fed officials. However, the reversal once again in stock prices suggests that the Fed can’t count on weaker stock prices to curtail the euphoric consumer. They are likely to have to continue to raise rates in coming months. The size of the May 16 rate hike is still in question: will it be 25 basis points or 50?

Looking Ahead: Week of April 24 to April 28
Market News International compiles this market consensus which surveys about 20 economists each week.

Tuesday
Market participants are expecting consumer confidence will edge down in April to 136 from a level of 136.7 in March. This would be a modest reaction to the stock market correction for the month and still reflects optimistic consumers.

Existing home sales are predicted to remain unchanged in March at a 4.75 million unit rate. Sales had jumped 6.7 percent in the previous month reflecting unseasonable weather conditions.

Wednesday
The market consensus is looking for durable goods orders to rise 2 percent in March after recording declines in both January and February. Despite the declines earlier in the quarter, durable goods orders have shown an upward trajectory over the past year.

Thursday
Market participants are expecting new jobless claims to rise 3,000 in the week ended April 22 from last week's 257,000 level.

Economists are predicting the employment cost index will rise 0.9 percent in the first quarter. Although this would be smaller than the fourth quarter gain of 1 percent, it represents an acceleration on a year over year basis from the 3.4 percent rate rise posted in the fourth quarter.

The market consensus calls for real GDP to show it grew at a 6 percent rate in the first quarter, down only modestly from the 7.3 percent surge recorded in the final three months of last year. This reflects strength across the board, but particularly in personal consumption expenditures. The GDP chain price deflator is expected to rise at a 2.3 percent rate, up from a 2 percent rate in the previous quarter. This does incorporate higher energy prices for the period. Economists estimate that real final sales grew at a 6.9 percent rate in the first quarter, faster than the 6 percent rate posted in the fourth quarter of 1999.

Friday
Personal income is predicted to post a 0.6 percent gain for March, reflecting the healthy rise in payrolls and wages last month. At the same time, personal consumption expenditures are expected to rise 0.5 percent. If these forecasts are realized, it would mean a slight uptick in the personal savings rate.

The market consensus is estimating that the Chicago purchasing managers’ index will edge down to 57 in April from a level of 57.4 in March. Despite the expected drop, the level still reflects healthy manufacturing activity.