Jobless claims at new low

We received another piece of good news about the economy on the final day of the year.  Weekly jobless claims fell 22,000 in the latest week to 432,000, well south of the Bloomberg forecast of 460,000 and the lowest level in almost 18 months.

The 4-week moving average continued in a downward trend, dropping 5,500 to 460,250, and continuing claims slipped 57,000 to 4.98 million.

Recognizing that seasonal adjustments can sometimes be difficult this time of year, the steady decline in weekly jobless claims is impressive and is one of the clearest indications that the economy is on the mend.

The drop in layoffs not only reflects rising optimism among businesses but it also shows that the worst losses in nonfarm payrolls are behind us.  Still, fewer job cutbacks by employers do not necessarily portend a rise in employment, at least at this point in the business cycle. But it is a prerequisite to job creation.

We’ll need to see steady increases in aggregate demand before the economy begins to create new jobs.

Unfortunately, a falling unemployment rate and rising nonfarm payrolls are among the last economic statistics to show improvement after a recession.

Expected end of tax credit wallops new home sales

New home sales fell a steep 11.3% to a seasonally-adjusted annual rate of 355,000 in November, which puts the supply of homes on the market at 7.9 months (up from 7.2 months).

Unlike existing home sales, which are recorded at closing, the sale of a new home is counted when a contract is signed. We did see a jump in new home sales in October as buyers rushed to beat the end of the first time home buyers tax credit, which had originally been set to expire November 30.

The extension and expansion of the tax credit, coupled with the growing economy and still-low mortgage rates, should lend support to the market next year.

Final 3Q GDP indicates economy limped out of recession

Gross Domestic Product - commonly referred to as GDP - is the broadest view of economic activity and is among the more complex pieces of economic data that the government releases each quarter simply because it covers so much territory.

That is the reason we have three separate releases - advance, preliminary, and final - from the government.

The final release for 3Q, which came out today, showed that GDP increased at an annual rate of 2.2%, down from the initial estimate of 3.5, and the downwardly revised gain of 2.8%.

It's a little discouraging to the downward revisions chip away at early gains, but the data are old (4Q ends in about one week) and most economic reports suggest that we'll see the economy continue to expand when the final quarter's advance report is released at the end of January.

Gains in weekly claims stall

But trend intact

Weekly initial jobless claims increased 7,000 to 480,000, while the 4-week moving average dropped 5,250 to 467,500.

Not really much to say.  The sharp improvement witnessed in November has stalled for now, but the general downward trend is still intact. 

Simply put – the chart above is reflecting gradual improvement in the labor market and a gradual improvement in economic activity.

Philly Fed reveals acceleration in manufacturing

Early in the week, the Empire Manufacturing Index showed that activity in New York was little changed from the prior month.  As mentioned in a prior post, the Empire survey tends to be volatile and “sudden shifts have to be taken in context with the overall trend” – see Empire stalls.

The Philly Fed’s Business Activity Index released today showed that manufacturing activity in the mid-Atlantic region accelerated at its fastest pace since April 2005.

The survey released by the Philadelphia Federal Reserve increased from 16.7 in November to 20.4 in December, above the Bloomberg forecast of 16.5 and the fifth-consecutive month the index has been in positive territory. A reading above zero is an indication that manufacturing is expanding in the region.

New orders did slip some but many of the subcomponents suggest continued improvement in the sector heading into 2010. 

Meanwhile, the employment index improved nearly 7 points to 6.3, the best reading in over two years and a sign that companies are finally starting to bring new workers onboard.

Prices paid did jump from 14.9 to 33.8, but prices received was nearly unchanged at –1.8.  Soft demand is keeping price increases in check.

One note of caution, the six-month forecast fell from 36.8 to 24.4, but that’s still well above zero, suggesting a modest degree of optimism remains.

Empire stalls

The Empire Manufacturing Index is a regional survey that looks at manufacturing in New York State and is compiled by the New York Federal Reserve.

In hindsight, the survey did a great job signaling the low point in manufacturing and the recovery that eventually ensued.

Because it is the first look at manufacturing during the current month, the narrow survey does garner some extra attention, but it tends to be volatile and sudden shifts have to be taken in context with the overall trend.

That said, the Empire Manufacturing Index fell from 23.5 in November to 2.6 in December, well below the  forecast offered by Bloomberg of 25 and a sign that output slowed markedly.  A reading of zero marks the line between contraction and expansion.

New orders and shipments decreased, but prices paid rose from 10.5 to 19.4, signaling rising pricing pressures at the early stages of production, which is likely tied to rising commodity prices.

But prices received fell from –2.6 to –9.2, as manufacturers have little recourse when it comes to passing along increased costs.

The steep drop in the index is disappointing, but as already mentioned, one month does not constitute a trend.  We’ll have to see what happens when the Philly Fed’s Business Activity Index is released later this week. And we’ll have to look at the ISM Manufacturing Index, which is a highly-sought-out survey that encompasses the entire country.

If a pause is detected, it is likely that we’re just looking at a one-month bump, in my view.

Commodities, oil fuel rise in import prices

Much of what makes up the index still contained

Led by a 7.3% rise in fuel costs, the import price index jumped a hefty 1.7% in November.  Ex-fuel, prices increased 0.4%, which comes on top of price increases that have averaged a like amount in the prior three months.

At first glance, the weakening dollar appears to be igniting a broad-based rise in import inflation, which at this early juncture in the business cycle, would be disturbing.

Digging deeper, the rise in core import inflation is directly the result of sharp gains in raw material costs, which can be tied in part to the falling dollar, while China’s strong appetite for commodities is also playing a role.

But outside basic commodities, pricing pressure are well contained.

Consumer goods, which make up one quarter of the index, have barely moved over the last four months.  And capital goods, which account for nearly a quarter of import prices, have averaged gains of less than 0.1% in each of the last four months, according to government data.

Credit the weak US economy and excess global capacity for the inability to boost prices.

Retail sales advance

Retail sales rang up an impressive increase November, bolstering evidence that the consumer may finally be participating in the economic recovery.

Details available at Examiner.com.

Cold weather draws down natural gas supplies

Natural gas prices jumped in trading today after the Energy Information Administration reported a larger-than-expected 64 billion cubic feet (bcf) decline in supplies to 3,773 bcf.

The relatively mild summer and weak industrial demand this year has left ample supplies of the commodity used to heat a majority of homes in the US, as stocks are still 472 bcf higher than last year at this time and 513 bcf above the 5-year average.

Consequently, prices remain low compared to much of the decade.

Rise in weekly jobless claims ends downward streak

Five-consecutive declines in weekly jobless claims came to and end in the latest week, with initial claims rising 17,000 to 474,000.  The 4-week moving average, however, continued its downward trend, dropping 7,750 to 473,750.

The decline shouldn’t be viewed in a negative light, as the favorable trend remains intact.  In addition, the end of the very positive streak, which saw claims decline from 532,000 to 457,000, isn’t surprising since initial claims can be volatile on a week by week basis.

Being more specific, the rise could be termed simply as “noise.”

Meanwhile, a sharp 303,000 decline in continuing claims to 5.16 million is encouraging since it could be signaling that folks in the unemployment line may finally be securing employment. However, the expiration of standard benefits, which typically last six months, are probably playing a role in the downward trend.

For a more detailed explanation of weekly claims, please see Economy 101: What are weekly jobless claims? on Examiner.com.  Additional articles are available on my homepage.

Sovereign debt worries back on the radar

Judging from recent action in the dollar and in the stock market, Dubai's announcement that it will put debt payments on hold reminded all of us that despite recent gains in global economic activity, unexpected surprises in the debt markets still have the potential to rattle investors.

Furthermore, Dubai's problems may be followed by troubles in Greece (see Greek debt threatens euro - Business Week), which is struggling with high debt loads of its own.

However, concerns that defaults in emerging markets might spread to major institutions in Europe and the US appear to be limited at this time given that measures of risk, such as swap spreads or LIBOR, remain at pre-credit crisis levels.

Wholesale inventories finally turn higher

It’s a bit dated because the most recent number is over six weeks old, but the first rise in inventories in over one year suggests that the destocking that occurred in response to the near collapse in demand late last year may finally be running its course.

The government reported this morning that wholesale inventories increased 0.3% in October, even as sales jumped an impressive 1.2%.  That brings the closely-watched inventories-to-sales ratio, or how many months it would take to liquidate stockpiles on hand, to 1.16.

At 1.16, the ratio is slightly below where it stood through much of  the expansion that occurred during the decade, and further gains in sales are likely to encourage firms to re-open idle plants and ramp up production.

Based on recent increases in industrial production and positive readings on surveys that measure manufacturing – the ISM and Philly come to mind – that is exactly what has been happening.

Still, let’s temper some of our/my enthusiasm given that gains have been modest, and the hole we must dig ourselves out of is wide and deep.

An uptick in hiring?

Definitely good news on the employment front;  however, companies have become very adept at managing the supply chain and keeping inventories lean, and it seems very unlikely that we will see a sharp upturn in the ratio that measures sales and inventories.

Disconnect between ISM services and jobless claims, nonfarm payrolls

Yesterday’s report that the ISM Non-Manufacturing Index – a measure of the broad-service sector – fell back to a level that suggested the sector was contracting again, seemingly at odds with the continued drop in jobless claims and today’s much better-than-expected nonfarm payroll numbers (see charts below).

Additionally, the sharp upward revision to October and November nonfarm payrolls suggests the economic recovery may not be as fragile as originally envisioned by many analysts – including myself, though I have been arguing against a double-dip recession.

So what gives?  A key measure of services has declined over the past two months and the employment subcomponent barely moved, rising from 41.1 to 41.6 (50 is the level at which jobs are neither being created nor destroyed). Yet, the government reported 58,000 new jobs among service industries.

The ISM’s new order subcomponent did remain firm in November, but other than that, it simply appears that the highly regarded survey, at worst, is not capturing the nascent optimism among some businesses.  At  best, it is highlighting how weak the recovery may be.  I tend to lean to the former.

Jobless claims, in my view, are an excellent barometer of economic health because falling claims indicate the economic activity is improving as companies become  more reluctant to release workers.

November’s 11,000 drop in nonfarm payrolls is the best reading in two years. 

But nonfarm payrolls are a lagging indicator in economic recoveries because businesses do not want to quickly rehire workers and be forced to lay them off if improving economic condition are temporary. 

Furthermore, firms continue to keep a sharp eye on expenses, and hiring budgets remain under the microscope.

Yes, we have a long way to go before the economy is consistently producing the level of employment needed to take a large bite out of the unemployment rate.  And the risk of a jobless recovery over the next year remains large, especially if economic gains remain modest.

But the nearly unchanged level of employment last month and the favorable trend over much of the year are a clear reflection of falling jobless claims and a signal that further gains in the economy are probably forthcoming.

Rising U.S. refinery capacity

Much has been made over the fact that a major refinery has not been built in the U.S. since the 1970.  Rising oil prices over much of the decade and gasoline prices north of $3 per gallon created cries by many that the country was in desperate need of new capacity.

Recently, the Energy Information released data that showed total U.S. refining capacity increased by 14% between 1997 and 2009, with the average annual capacity increase of about 185 thousand barrels per day (Mbbl/d) over this period, equivalent to adding one and a half average-sized refineries each year.

How?  Refiners can increase capacity at existing sites by modifying equipment to increase product flow and by adding new distillation units, according to the EIA.

Net refining margins and return on investment reached historic high levels from 2004 to 2007, encouraging several companies to announce expansion plans, per EIA data.

But at times rising demand for gasoline taxed the nation’s refineries, especially after Hurricane Katrina and Hurricane Rita did plenty of damage to facilities along the Gulf Coast.

Over the past several quarters, however, refining margins have declined sharply, and petroleum product demand has declined in response to weak economic activity.

A look at the latest inventory of gasoline and distillates, which includes heating oil and diesel fuel, shows ample supplies are available.

Service sector contracting again

But drop in jobless claims is encouraging

Following two months above 50 – the level that marks the line between contraction and expansion, the ISM Non-Manufacturing Index showed that the broad-based service sector contracted last month.

The closely-followed survey fell from 50.6 in October to 48.7 in November, below the Bloomberg forecast of 52.0.  The economic recovery has been modest thus far, and some analysts expected a double-dip recession. 

Weakness in the service sector last month, which accounts for most of the country’s GDP, bolstered their case, as the index has slipped for two consecutive months.

Jobless claims point to further economic gains

However, today’s report on jobless claims paint a different picture.  Weekly initial jobless claims remain in a downward trend, falling another 5,000 to 457,000, the lowest reading since September 2008.

The 4-week moving average dropped 14,250 to 481,250, but continuing claims increased 28,000 to 5,465,000.

The labor market has taken a  beating in the recession, and the unemployment rate now stands above 10%. Moreover, companies have shed over 7 million jobs since the recession began, according to data published by the government.

But the improvement in jobless claims is a clear indicator that companies are growing more optimistic about the recovery, and we may see further gains tomorrow when the government provides the latest on the labor market.

A reversal in the positive trend for weekly jobless claims would be disconcerting, signaling a worsening in the employment situation and a return to a contracting economy, but in my view, that is unlikely to happen.

Fed's Beige Book suggests recovery gaining traction

The Fed's Beige Book, which is a compilation of anecdotal reports from the twelve Federal Reserve districts, indicated that economic conditions have "improved modestly" since the last report.

Consumer spending has picked up modestly, according to the report, while manufacturing was "said to be, on balance, steady to moderately improving across most of the country, while conditions in the nonfinancial service sector generally strengthened somewhat."

Home sales and construction activity improved across much of the nation, though prices were generally said to be flat or still declining somewhat. However, the level of new residential construction activity was generally characterized as weak.

No big surprise - commercial real estate conditions were widely characterized as weak and, in many cases, deteriorating further. Market conditions were reported to have weakened in virtually all districts, with rising vacancy rates, downward pressure on rents, and little, if any, new development.

The Achilles heel at this point is commercial real estate, which could put added pressures on some banks, but the recovery, for now, is moving ahead at a modest pace. An improvement in the labor market would go along way in putting the recovery on self-sustaining pace.

Pending homes sales climb again

Expectations that the first time home buyers tax credit was set to expire at the end of November helped to fuel the ninth consecutive monthly gain in the Pending Home Sales Index.

The index designed to forecast existing home sales now stands at the highest levels since March 2006.

BoJ to take new steps to aid economy, fight deflation

The Bank of Japan (BoJ) decided to take new steps at an unscheduled meeting after the country's prime minister had warned that deflation and a surging yen threatened to erase nascent gains in economic activity.

The BoJ will not return to its full-blown policy of quantitative easing - pumping excess reserves into the financial system, over and above what is needed to keep rates at near zero - that was used to fight deflation earlier in the decade.

But it does plan to supply additional funds to the economy, which the bank "characterized as quantitative easing in the broad sense of the term, as it is aimed at creating an environment with ample liquidity," according to a leading Japanese financial daily.

The bursting of the Japanese stock and real estate bubbles in the early 1990s led to a stagnant economy that has lasted almost 20 years. A strong yen and feeble domestic demand helped produce a deflationary environment in the early part of the decade, which encouraged policymakers in the US to take much more aggressive action during the current economic debacle that unfolded last year.

Now is not the time to be tepid.

The BoJ voted to hold its overnight lending rate at 0.1% and avoided any direct comments on the strong yen.

Manufacturing growth slows

Manufacturers sharply curtailed production late last year and early this year, helping them get a handle on excess inventories that sprung from a near collapse in demand following the credit crisis in late 2008.

With the worst of the contraction behind us, manufacturers put the brakes on production cuts in 2Q and output began to stabilize by summer. Subsequent gains, however, have been modest and there has been little in the way of an acceleration over the past four months (see chart).

Taking a look at the latest on the manufacturing front, the ISM Manufacturing Index fell from 55.7 in October to 53.6 in November, below the forecast of 55.0 offered by Bloomberg. A reading of 50 marks the line between expansion and contraction.

Four straight months of increased production is good news following extreme weakness earlier in the year, and it underscores that the economy has begun to rebound. But the modest gains also signal that the rebound in activity has been gradual.

Prices paid slipped from 65.0 to 55.0, indicating a lessening of inflationary pressures at the early stages of production. And exports inched up to 56.0, the fifth consecutive monthly gain amid a continued improvement in the global economy. But the employment subcomponent fell back from 53.1 to 50.8 – not so good news.

Modest increases in aggregate demand and the need to restock depleted inventories should continue to support production in the coming months.

RBA puts interest rates on upward path

The Reserve Bank of Australia announced its third rate increase in as many months, hiking its cash rate by 25 bp to 3.75% as expected. The RBA noted in its press release that "global economy has resumed growth," and in China and much of Asia, the "recovery has been much quicker to date and prospects appear to be for good growth in 2010."

The downturn in Australia was relatively mild, and Australia's central bank was the first major central bank to begin reversing the monetary stimulus put in place.

Since the risk of a "serious contraction" has passed, per the RBA, monetary authorities have been gradually boosting rates.

Bank of Japan calls emergency meeting

It's been a while since I've taken a look at Japan, but a surprise announcement this evening that the Bank of Japan will call an emergency meeting today amid the rising threat of deflation is worthy of mention.

The rising yen is adding to deflationary pressure and undermining the competitiveness of its export-driven economy. And gains in industrial production seen earlier in the year have been diminishing, according to Bloomberg.

With its key interest rate at 0.1%, there is little the BoJ can do at this point, though it could resume its policy of quantitative easing - pumping additional reserves into the banking system beyond what is needed to keep rates at near zero.

Natural gas surplus

Wednesday’s report that natural gas supplies increased by 2 billion cubic feet (bcf) to 3,835 bcf probably marks the peak in supplies heading into the winter heating season.

Stocks are now 404 bcf higher than last year at this time and 442 bcf above the 5-year average of 3,393 bcf.  The recession, which has hurt industrial demand, heavy injections earlier in the year, and the mild summer in much of the country account for the surplus in the commodity used to heat just over half the homes in the US.

And that surplus goes a long way in explaining why natural gas prices remain at low levels.

Sharp drop in jobless claims argues against double-dip recession

Recent reports on the economy, including falling housing starts, sluggish industrial production, and the latest downward revision in 3Q GDP have given proponents of the double-dip recession argument (or a W-shaped recovery) added ammunition in recent weeks. 

But today’s report from the Labor Department of a steep decline in weekly jobless claims is probably the most solid argument that the slow and fragile economic recovery may be on a firmer foundation than many believed possible.

Weekly initial jobless claims fell 35,000 in the week ending November 21 to 466,000, the lowest level in 14 months and well below the consensus forecast offered by Bloomberg of 495,000.

The 4-week moving average continues to cooperate, dropping 16,500 to 496,500, the first dip below 500,000 in over a year. And continuing claims slid 190,000 to 5.42 million. However, the expiration of standard benefits and not job creation is probably the main reason for the downward trend.

Weekly jobless claims can be volatile and seasonal adjustments do not always accurately capture recurring changes in the job market.  But in searching through the data, I did not find any comments that Wednesday’s early report (weekly claims are typically reported every Thursday)  influenced the latest drop.

The timeliness of jobless claims makes this one of my favorite barometers of economic activity, and the downward trend in layoffs implies that companies are slowly detecting an improvement in the economic outlook.

In addition, today’s steep decline provides hope that we may soon see diminishing job losses and eventual gains in employment.

Too soon to give the all clear sign

Still, any enthusiasm should be tempered with the second-straight monthly decline in consumer sentiment, as measured by the University of Michigan’s survey on confidence.  This doesn’t bode well heading into the all-important Christmas shopping season.

And an unexpected drop in orders for durable goods, which was also released this morning, suggests a modest recovery at best.

Fed minutes and worries about inflation, bubbles

The minutes released today from the Fed's meeting early this month made if very clear that Committee members are intent on keeping rates at rock-bottom levels for the foreseeable future. But policymakers are not operating in a vacuum and discussed risks related to the very loose monetary policy that has been in place for nearly a year.

Members are mindful that very low short-term rates could lead to "excessive risk-taking in financial markets or an unanchoring of inflation expectations."

Officials in both China and Japan have recently expressed concern that low interest rates in the U.S. could be fueling the carry trade - borrowing where rates are cheap and investing the proceeds in parts of the world that fetch higher returns - and speculative bubbles in Asia.

Although some members saw inflation risks leaning to the downside in the near term, others felt that risks were tilted to the upside over a longer horizon, because of the possibility that inflation expectations could rise as a result of the public’s concerns about extraordinary monetary policy stimulus and large federal budget deficits.

Moreover, these participants noted that banks might seek to appreciably reduce their excess reserves as the economy improves by purchasing securities or by easing credit standards and expanding their lending substantially. Either way, the money supply would surge.

Such a development, if not offset by Federal Reserve actions, could give additional impetus to spending and, potentially, to actual and expected inflation, the minutes said.

To keep inflation expectations anchored, all agreed it was important for policy to be responsive to changes in the economic outlook and for the Fed to continue to clearly communicate its ability and intent to begin "withdrawing monetary policy accommodation at the appropriate time and
pace."

In my view, a small rate hike would send a strong signal to the financial markets that the U.S. is serious about its commitment to a strong dollar and stable inflation, and it could help dampen the speculation in gold as well as curtail some of the commodity inflation we are seeing (see Rate hike: sooner rather than later?). However, a minor boost should have little negative impact on the fragile economic recovery.

With the unemployment rate now above 10% and poised to head higher, there is little likelihood that Fed will take that kind of bold action. Nonfarm payrolls, which showed no signs of stabilizing over the past three months (see Thoughts on unemployment), will need to begin evening out before the Fed signals it is in the twilight of its current policy.

Baltic Dry Index signaling further gains in global economy

Back in early September, I published an article entitled, “Baltic Dry Index flashing yellow.”

At that time, the important measure of shipping rates had fallen approximately 40% from its early June peak, suggesting a possible pause in the global economic recovery. Or a spate of new ships coming online.

But what a difference a couple of months can make.  More specifically, what a difference just three weeks can make!

The chart provided by Bloomberg shows that shipping rates have surged since the beginning of the month, suggesting that economic activity has picked up considerably, even if technical factors may be boosting rates.

Much of the improvement is likely coming out of China amid strong demand for raw materials , but the economy in the U.S. and Europe has also shown signs of life recently.

Manufacturing expands per Philly Fed

The Philadelphia Fed’s Business Outlook Survey indicates that output in the mid-Atlantic regions accelerated in the latest month.

The Philly Fed index increased from 11.5 in October to 16.7 in November, topping the forecast by Bloomberg of 12.0  A reading of zero is a sign that production is neither increasing nor decreasing.

New orders and shipments improved, but there was little in the way of new employment.  On the inflation front, prices received increased slightly to –1.5 as the lack of demand at the retail level makes it very difficult for companies to raise prices.

Companies are still optimistic going six months out as  the future general activity index remained positive for the 11th consecutive month, but the index did decline from 39.8 in October to 36.8.  Still, the level is near where we saw it over 5 years ago, which is an encouraging sign that manufacturing will continue to recover as companies re-stock.

However, the strength and length of the manufacturing recovery will depend heavily upon how strong demand comes back in the U.S.

Weekly jobless claims hold steady

Weekly initial jobless claims held steady at 505,000 versus one week ago, but the slow downward trend remains intact, suggesting the economic recovery that probably began during July is still in place.

The 4-week moving average, which removes some of the volatility in the weekly number, fell 6,500 to 514,000, while continuing claims, which have dropped dramatically in recent months, fell another 39,000 to 5.6 million.

Before we get too excited about the drop in continuing claims that totals over1 million from its peak, it is important to note that much of the decline is probably the result of standard benefits expiring after six months rather than job creation, especially given that the economy is still shedding jobs at a heady pace (see Thoughts on unemployment).

Nonetheless, the drop in weekly claims is modestly encouraging and signals the economy is slowly recovering from a very deep hole, but the slow pace and still-high level is a clear sign that we are not experiencing a robust recovery.

For a detailed explanation of weekly claims, please see Economy 101: What are weekly jobless claims?

A pause in the new home market

New home sales make up less than 10% of overall housing sales, but a plunge in housing starts last month suggests the originally-scheduled end of the new home buyers tax credit had an adverse impact on the market in October.

Housing starts fell a steep 10.6% last month to a seasonally adjusted annual rate of 529,000.  Building permits, which are used for forecast future starts, fell 4.0% to 552,000.  Single-family authorization, which is considered a more important indicator, was down just 0.2% to 451,000.

The declines exceeded forecasts but are likely the result of the expected expiration of the $8,000 tax credit for first time home buyers, which had not yet been extended by Congress.

Rising real estate construction spending aided GDP in 3Q and further gains are a crucial ingredient if the economic recovery is to become self-sustaining.

Elsewhere, yesterday’s release of the Housing Market Index, which was unchanged from October’s downwardly revised reading of 17, also signaled the tentative situation builders were in as they awaited Congressional approval of an extension of the tax credit.

A reading of 50 indicates builders are neither optimistic nor pessimistic about the new home market.

The extension and expansion of the credit, coupled with historically low mortgage rates and improving affordability, are expected to lend support to the housing market going forward. But high unemployment and a still high level of layoffs will probably remain headwinds to a housing recovery.

Outside energy and food, wholesale prices fall

Led by steep 1.6% gains in both energy and food, the Producer Price Index increased a modest 0.3% in October, the third increase in five months.  Food and energy have been fairly volatile in recent months and have had a major impact on the headline figure.

The core rate, which removes the two categories, fell a steep 0.6% last month amid lower prices for light motor trucks and passenger cars, which fell 5.2% and 0.5%, respectively.

Inflation at the wholesale level remains benign, though the best news is behind us.

Sluggish industrial production

Following three solid monthly advances, industrial production in October increased a scant 0.1%. Last month's gain occurred because October's cold weather produced a 1.6% rise in utility production. Hence, remove the energy component and manufacturing fell 0.1%, the first drop since June.

The small rise in the headline figure produced a 0.2% rise in capacity utilization to 70.7%, but with plenty of slack in the economy, the threat of inflation remains distant at this time, which the Fed made very clear in its last statement.

The economy is still moving ahead, but the recovery is fragile and the pace remains choppy as evidenced by the latest numbers.

Empire gives back some of recent gains

The Empire Manufacturing Index is the first look at goods producers each month, though it is a narrow measure and only reflects conditions in New York.

In November, the survey fell 11 points to 23.5, but remains well above zero, which marks the line between expansion and contraction.  Shipments, new orders, and prices eased; however, the drop is not worrisome, in my view, as the index has been on an almost uninterrupted, upward pace since early in the year.

A look at business conditions going out six months did improve to its best level in about 5 years, rising just over one point to 57.0.

Inflation pressure slowly growing from overseas

Prices from overseas increased 0.7% in October, the seventh increase in eight months as fuel prices jumped a steep 1.8%.  Excluding fuel, prices increased a modest 0.4%, which follows similar gains over the prior two months.

Strong increases in industrial supplies over the last three months have boosted import inflation at the core level, which is not much of a surprise given gains in commodity prices.

The weakening dollar may be playing a role, but at this point it is probably minor since depressed demand in the U.S. makes it very difficult to raise prices.  Moreover, currency fluctuations do not immediately translate into price changes due to hedging techniques.

Gains from oil disappear

Prices remain below levels seen one year ago, but the steep decline that was fueled primarily by falling oil prices has mostly dissipated.

Trade deficit widens on higher oil bill

The US trade deficit widened from $30.8 billion in August to $36.5 billion in September amid a surge in imports, while the continued rise in exports suggests the global economy remains on the mend.

In the month of September, imports jumped $9.3 billion to $159.1 billion, while exports increased $3.7 billion to $128.3 billion. 

Much of the deterioration in the trade gap can be blamed on a $4.1 billion increase in the nation’s bill for oil.  Higher prices played a role, thanks mostly to the weaker dollar, but oil imports also jumped.

If the dollar remains on a downward path, speculators and institutional investors may continue to put money into commodities, including crude, which could further exacerbate the trade deficit and negate the favorable impact from rising exports.

The worsening trade gap is likely to hamper GDP when the advance figures are updated later in the month.

Consumer sentiment stuck in a range

Economic activity is no longer contracting, as evidenced by 3Q’s rise in GDP, but the inability of the economy to produce jobs is weighing heavily on consumer sentiment.

Details available via Examiner.com.

Fewer jobless claims suggest recovery intact

Weekly initial jobless claims now stand at 502,000, down 12,000 in the latest week.

Still too high but the trend is encouraging.  Details available at Examiner.com.

Production strong in Germany, but sentiment sours some

ZEW sends a mixed signal

A couple of key reports from Germany this week are sending out mixed signals.  Industrial production in September surged by 2.7% following an impressive 1.8% rise in the prior month.  Foreign demand provided much of the boost as the global economy continues to power ahead, bolstering Germany’s export-dependent economy.

However, institutional sentiment, though still has high levels, pulled back some in the latest month. The respected ZEW survey fell 4.9 points in November t0 51.9 points but remains well above the historical average of 26.9.

The Center for European Economic Research pointed out that analysts remain cautious as to how private consumption will evolve, especially due to the uncertainties that abound in the labor market.

Sentiment among analysts started in an uptrend late last year and continued to surge through much of the first part of 2009.  The initial optimism was a bit premature, in my view, but Europe’s largest economy has started on the road to recovery.

Fedspeak - Why rates are expected to remain low

The FOMC's press release that accompanies a rate decision provides a quick look at what Committee members think about the economy along with where interest rates might be headed. In it's statement last week, the Fed said economic conditions are "likely to warrant exceptionally low levels of the federal funds rate for an extended period." Not a big surprise that it left the language intact.

Comments from Federal Reserve presidents in between meetings give us additional insight into FOMC decisions as well as provide us clues that might signal an impending change in policy.

First, Atlanta Fed chief Dennis Lockhart said in his prepared remarks today that he believes an economic recovery probably got underway this summer. In particular, he pointed out that housing prices appear to have bottomed and risk spreads have normalized. Both are key to self-sustaining recovery.

But he cautioned that his "baseline forecast is for a relatively subdued pace of growth beyond the current quarter and through the medium term. The potential sluggishness of the recovery partly reflects certain unique characteristics of this recession.

It was led by a crisis in banking and capital markets that was triggered by a sharp and persistent reduction in valuations of residential real estate assets."

Lockhart also said problems in commercial real estate are "very worrisome for parts of the banking industry."

San Francisco President Janet Yellin made similar comments today in a speech about the economy and real estate. Yellin reminded her audience that the economy has started to move ahead, but "the strength and durability of the expansion is in question.

Some of the rebound is due to temporary government programs and a swing in inventory investment that will not provide an ongoing source of growth."

Though we are hearing cautious optimism for the Fed, fears that a subdued recovery will not produce the jobs needed to bring down the unemployment rate implies that the fed funds rate will hover near zero for the foreseeable future.

Thoughts on unemployment

October’s rise  in the unemployment rate past 10% had been eventually expected but is still sobering and a reminder that the high rate of unemployment is a daunting task for both policymakers and those who have find themselves downsized out of a job.

A broader measure of unemployment, known as U-6 which includes discouraged workers not counted under the standard definition as well as part-timers who want full time work, rose from 17.0% to 17.5%.

Because it appears that the economic recovery will be gradual (see L, W, U, V – the alphabet soup of economic recoveries) and job growth is a lagging indicator, unemployment above 10% is likely to persist for some time, while an eventual rate hike by the Federal Reserve will be pushed further into the future.

I covered most of the details of today’s release at Examiner.com.  Although the chart below indicates that the pace of job losses is slowing, the last three months show there has been very little progress.

Yes, we are seeing modest declines in weekly jobless claims as companies gradually turn more optimistic on the economy, but improvement has been far too slow and claims north of 500,000 each week suggests the jobless rate may be headed higher.

Companies continue to work off inventories

Much today’s attention is on the unemployment rate, which jumped past 10% in October, the release this morning of wholesale inventories indicates that the rapid destocking cycle that began last year is slowly but not significantly abating.

The U.S. Census Bureau reported that wholesale inventories fell 0.9% in September, while sales grew 0.7%.  Although sales continue to rise and have gained  ground for six-straight months, manufacturers have been reluctant to quickly ramp up production, hampering gains in economic activity.

As viewed by the chart above, companies continue to work off goods on hand, rather than significantly boost production.  Note that the inventories-to-sales ratio, or how many months companies need to completely liquidate inventories, fell from 1.20 to 1.18 and remains in a sharp, downward trend.

The economy is improving and demand overseas, especially from Asia, has accelerated.  But the domestic recovery is still fragile, and consumer demand, which is starting to show signs of expanding, is being held back by high unemployment, damaged balance sheets, and sluggish growth in incomes.

Rapidly falling inventories should eventually add to economic activity as companies restart idle production lines in order to meet expected demand. But these same firms are in no hurry to significantly raise output.

Natural gas supplies near peak

Natural gas supplies rose another 29 billion cubic feet (bcf) in the latest week and now stand at 3,788 bcf as the country heads into winter.  We may see another increase next week or the following week, but as temperatures continue to cool down, supplies are topping out.

According to the Energy Information Administration, stocks are 379 bcf higher than last year at this time and 414 bcf above the 5-year average of 3,374 bcf. 

A relatively mild summer in much of the country, which reduced electricity needs, and the decline in industrial demand that was tied to the recession are key reasons for the ample supplies heading into the colder months.

The country has also seen big increases in natural gas production recently, though falling prices earlier in the year stunted production.

Productivity soars

Led by a 13.6% rise in manufacturing productivity, the largest since the series began back in 1987, nonfarm business productivity soared at an annualized rate of 9.5% in 3Q, according to preliminary data. Unit labor costs, which are heavily influenced by productivity, fell a steep 5.2% in 3Q.

Forecasts provided by Bloomberg News called for a 6.3% increase in productivity and a 3.9% decline in unit labor costs.

Notably, unit labor costs declined 3.6% over the last four quarters—the largest decrease since the series began in 1948, according to the government. With labor costs, which are the largest piece of the expense equation for most businesses, well under control, the risk of an unwanted rise in inflation is highly unlikely.

No real surprises despite the big miss by forecasters

Huge gains in productivity and corresponding declines in unit labor costs are to be expected in the early stages of an economic recovery because firms are reluctant to add new workers even as production pick up. And in this case, the continuation in job losses added to the out-sized increases in productivity.

As layoffs wind down and hiring picks up (as many analysts anticipate will eventually occur), productivity gains will eventually begin to slow.

Jobless claims resume downward trend

It’s been a slow and painful drop but the economic recovery is gradually reducing the number of weekly initial jobless claims.  In the latest week, weekly claims fell 20,000 to 512,000, the lowest since the beginning of the year.

Details are available at Examiner.com.

Rate hike: sooner rather than later?

The Fed announced no changes to interest rates today and made only modest adjustments to its commentary (see No surprises from Fed...). Following in the path of former Chairman Alan Greenspan, Ben Bernanke is not one to surprise financial markets and shifts in policy tend to be telegraphed in advance.

Note that even the language that conditions "warrant exceptionally low levels of the federal funds rate for an extended period" remained in the statement despite talk from analysts that the FOMC would tweak the language as it eventually prepares to raise interest rates.

If we are going to see changes at the December meeting, we are more likely to hear talk from Fed officials in speeches in the upcoming weeks, rather than get blind-sided at a Fed meeting.

That said, it might have been beneficial for a change in the language referring to rates and an eventual hike at the December meeting to 25 bp followed by another small increase to 50 bp in January.

Yes, the economy remains in a fragile state, and the unemployment rate is probably headed higher. Moreover, political pressure from lawmakers for the Fed to continue doing much of the heavy lifting remains intense. Plus, the protests from the executive and legislative branches would probably be deafening.

However, a symbolic increase would not harm the economy, in my my view, as rates would still be near rock-bottom levels. And the emergency situation and free-fall in the economy late last year that brought about near zero interest rates has abated.

A small increase would help attract the capital needed to fund large deficits and would send a strong message to international investors that the Fed is serious about the Treasury's strong dollar policy. Furthermore, it may slow some of the asset inflation we've been seeing in the commodity markets.

Do I anticipate this will occur? Highly doubtful. Bernanke & Co. will most likely hold the fed funds rate at its current target of 0-0.25% until job creation is on a self-sustaining, upward path.

Service sector begins to slowly dig out of deep hole

Manufacturing may be rebounding at a solid pace, but today’s report on the service sector suggests non-manufacturing industries have only begun to stabilize.

The ISM Non-Manufacturing Index fell from 50.6 in September to 50.3 in October, shy of the consensus estimate of 51.6 provided by Bloomberg.  A reading of  50 is neither expansionary nor shows the sector is contracting.  And at 50.6, the service sector, for all practical proposes, has just stopped shrinking.

On the positive side, the trend over the past 12 months has been slowly to the upside.  Unfortunately, the improvement has not made a dent in the jobless rate, and the employment component of the index remains weak, falling 3.2 points to 41.1.

ADP’s employment report, which came out this morning, showed that the private sector shed another 203,000 jobs last month.  Friday’s nonfarm payroll report will provide greater clarity on how the labor market performed last month.

Pending home sales on strong upward trajectory

The Pending Home Sales Index, which is a forward-looking indicator of existing home sales based on contracts signed, surged ahead for a record eight-consecutive months, providing the latest evidence that the housing market is on the road to recovery.

Pending home sales increased by 6.1% to 110.1 in September, which puts the index 21.2% above a year ago – the largest annual gain since the index began in 2001, according to the National Association of Realtors.

“We’re witnessing a rush of first-time buyers trying to beat the expiration of the (first-time home buyer) tax credit at the end of this month,” the chief economist for the NAR said.

But he cautioned,“We’re clearly not out of the woods because an excess of homes remains on the market despite recent improvement. Although current inventory is getting closer to price equilibrium, foreclosures will continue to enter the pipeline.”

Not missing an opportunity to lobby Congress to extend the subsidy, he added that “an extended and expanded tax credit would help absorb this incoming inventory.”

Foreclosures are likely to rise next year, according to analysts, and an extension of the credit may be warranted.  But pent-up home demand, coupled with historically low interest rates and the big rise in affordability over the past couple of years, may go a long way in absorbing additional inventories.

A strong foundation for a more permanent economic recovery must include rising home sales and rising  home prices.

Factories shift into higher hear

ISM at 30-month high

A key gauge of manufacturing expanded at its fastest pace since April 2006, suggesting the economic recovery that likely began late in the summer is gathering momentum.

The ISM Manufacturing Index improved from 52.6 in September to 55.7 in October, topping forecasts by about two percentage points and rising in nine of the past ten months. A reading above 50 is expansionary.

New orders pulled back slightly but continued to expand, falling 2.3 points to 58.5. But production surged 7.6 points to 63.3 as companies continue to replenish depleted stockpiles in the wake a the dearth in activity late last year and early this year.

Notably, employment moved above 50 for the first time in 15 months, indicating that workers are needed to meet expanding output.  More importantly, it is a signal that firms are slowly growing more optimistic that the recovery in place is more than just a temporary burst of economic activity.

Lingering impact of recession haunts consumers

The steep contraction the economy experienced in the months after the failure of Lehman Brothers and the subsequent freezing in the credit markets are well behind us and the improvement in consumer sentiment, as measured by the University of Michigan’s survey, has improved considerably.

But the fallout from the worst recession in decades has severely impacted the labor market.  With the unemployment rate probably poised to break past 10%, consumer confidence has barely budged out of the range it has been over the last 6 month.

So it shouldn’t come as a surprise that  job insecurities and worries about finances pushed the index from 73.5 in September to 70.6 in October.

The majority of consumers reported that their finances had worsened in October for the thirteenth consecutive month—the longest and deepest decline in the sixty-year history of the survey, according to the University of Michigan.

The economy has begun to climb out of the deep hole it fell into over the last 18 months, but many of us are not feeling much better about the economy. 

And with the Christmas shopping season just around the corner, a lack of visible improvement in consumer attitudes may depress spending in the final months of the year.

Chicago PMI surges ahead

The Chicago Purchasing Managers' Index jumped from 46.1 in September to 54.2 in October, easily beating the Bloomberg estimate of 48.5 and hitting its best level in over one year. A reading above 50 indicates that Midwestern manufacturers are expanding production.

The upbeat reading is welcome and the trend is favorable, but the index tends to be volatile. The ISM Manufacturing Index, which is a look at manufacturing on a national basis, is more closely followed and will provide a cleaner look at goods producers when it is released next week.

Q3 GDP revisited

Early data released yesterday showed the Great Recession that began in late 2007 unofficially ended in Q3 as the economy expanded at an annual rate of 3.5%.

I think it’s worth taking a moment to see what drove the economy forward last quarter and try to determine what might happen over the next several months.

First of all, 2.36 percentage points of of growth, nearly two-thirds of the gain, came from an improvement in personal consumption.  Since personal consumption makes up 70% of total economic activity, stingy consumers, who have been hunkering down, opened up their billfolds and helped to drive the first increase in GDP in five quarters.

Drilling down a bit further, durable goods made up 1.79 percentage points, including 1.47 percentage points from  automobiles and parts.  What does this all mean?  Simple, cash for clunkers played a major roll in Q3’s economic turnaround.

Moreover, 0.48 percentage points came from higher government spending. So it doesn’t take a math whiz to realize that over half the rise in GDP came from the government’s stimulus package.

Unfortunately, the sugar high the auto industry received from the cash for clunkers program has quickly faded, and we probably won’t see gains from the auto sector extending into Q4.

But there are some bright spots going forward. 

Businesses are starting to ramp up production again, with inventory accumulation adding 0.94 percentage points to economic activity.  And because excess stockpiles were rapidly depleted in the earlier months of the recession, we may continue to see improvements in this category.

Consumer spending may be a bit tenuous going forward since job anxieties remain high and balance sheets are still in need of repair.  If nonfarm payroll growth begins to tick higher by year end and continues to occur into 2010, consumer spending may finally begin to contribute to growth on a more permanent basis.

Hence, there are good reasons to be cautiously optimistic.

Jobless claims point to little improvement in the labor market

The economy has started to grow again as evidenced by the first report on Q3 GDP, but companies continue to shed jobs at  a pace that suggests we have not yet seen a peak in the jobless rate.

Weekly initial jobless claims dipped a scant 1,000 to 530,000 in the latest week, while the 4-week moving average fell 6,000 to 526,250.  At an uncomfortably high level above 500,000, next week’s report on nonfarm payrolls is probably set to disappoint.

Continuing claims, however, dropped 148,000 to 5,797,000. Still, the decline is more likely to be occurring because standard six-month benefits are running out.

 

Although manufacturing is growing again as companies rebuild depleted stockpiles, and the stock market continues to foreshadow an improving economy, the labor market has yet experience the turnaround.

Job growth typically lags in an economic recovery. And the modest growth we’ve seen so far suggests a jobless recovery may be on the horizon.

IFO shows Germany business confidence improves

Business confidence in Europe’s largest economy continues to gather steam amid signs that the global economy is improving.

Germany’s IFO Business Climate Index increased by 0.6 points to 91.9 in October, the best reading in just over a year. Moreover, expectations regarding future growth continue to push ahead.

Available survey indicators continue to signal an ongoing stabilization of economic activity, according to the European Central Bank. “In particular, the euro area should benefit from a recovery in exports, the significant macroeconomic stimulus under way, and the measures taken to restore the functioning of the financial system.”

Germany is heavily dependent upon exports and was hit hard by the global recession.

Semiconductor sales power up

Semiconductor sales jumped 5% in August to $19.1 billion, the he Semiconductor Industry Association (SIA) reported earlier in the month.

“Continuing recovery of consumer spending led the sixth-consecutive month of sequential growth in semiconductor sales,” said SIA President George Scalise. “Various incentive programs for energy-efficient products, ranging from automobiles to home appliances, have bolstered demand for semiconductors, which deliver critical enabling technology for reducing energy consumption.

Growing sales of netbook personal computers have also helped, Scalise continued.  “Notwithstanding the slow recovery of demand from the enterprise sector, we are encouraged that industry momentum has turned positive following the steepest downturn in more than a decade,” he concluded.

Existing home sales roar ahead

Following a modest pullback in August, existing home sales jumped an impressive 9.4% to an annual rate of 5.57 million units in September, exceeding the Bloomberg forecast of 5.35 million units and the highest reading since July 2007.

Existing home sales make up over 90% of all housing sales, and the fifth increase in six months, coupled with the best reading in over two years, indicates the housing market is well on the road to recovery.

One caveat: the National Association of Realtors said, “Much of the momentum is from people responding to the first-time buyer tax credit, which is freeing many sellers to make a trade and buy another home.” Historically low interest rates are adding to the upbeat mood.

Policymakers are concerned that an abrupt end to the tax credit, which is set to end on November 30, could bring the improvement in housing to an abrupt halt for several months, and realtors have been heavily lobbying for an extension of the credit.

Still, total housing inventory fell 7.5%to 3.63 million, which represents an 7.8-month supply at the current sales pace, down from an 9.3-month supply in August. Unsold inventory totals are 15.0 percent below a year ago.

“The current housing supply is the lowest we’ve seen in two and a half years,” NAR economist Lawrence Yun said. “If we could continue to absorb inventory at this pace, home prices would return to normal, modest appreciation patterns next year."

That comment seems to go against the conventional wisdom that a new wave of foreclosures next year will likely pressure prices. Stay tuned.

Jobless claims disappoint but trend still favorable

Weekly initial jobless claims moved higher for the first time in a month, increasing from last week’s upwardly-revised reading of 520,000 to 531,000.  This tops the consensus of 519,000, according to Bloomberg.

The 4-week moving average remained in a downward trend but declined by just 750 to 532,250.  News was a bit brighter for continuing claims, which declined by 98,000 to 5.9 million, though much for the decline is probably coming from recipients who no longer qualify for the six months of standard benefits.

Weekly jobless claims can be volatile but provide nearly a real-time look at economic activity.  The decline from earlier in the year has been painfully slow but shows that companies are gradually growing more optimistic about economic prospects.

But with the unemployment rate poised to crack 10% for the first time since 1983, leaders in Congress are starting to talk about another stimulus package.  In my view, a more efficient use of the original $787 billion plan would suffice.

Fed's Beige Books gives reason for cautious optimism

The Fed's Beige Book, which is a summary of economic conditions in each of the Federal Reserve's 12 districts, indicated that economic activity has either stabilized or displayed modest improvements in many sectors since the last report.

"Leading the more positive sector reports among districts were residential real estate and manufacturing, both of which continued a pattern of improvement that emerged over the summer. Reports on consumer spending and nonfinancial services were mixed. Commercial real estate was reported to be one of the weakest sectors."

It is no surprise, in my view, that the Fed is detecting an improvement in manufacturing and in residential real estate given that much of the data out recently are reflecting gains. Consumer spending has been more tenuous, while commercial real estate may be the Achilles heel of the economy.

Home builders receive reality check

The housing market has bottomed and appears to be on its long-awaited road to recovery, in my view.  But rock bottom mortgage rates and the first-time home buyer tax credit are not luring potential buyers back into the new home market the way many policy makers would like to see as evidenced by the latest data on the industry.

Yesterday, the NAHB/Wells Fargo Housing Market Index slipped from 19 in September to 18 in October, pointing to a drop in builder sentiment as the $8,000 tax credit for first time home-buyers nears expiration at the end of November. 

A reading of 50 is neither pessimistic nor optimistic.

As noted by the chart below, a drop in prospective buyer (green line) also impacted confidence.  But builders continue to heavily lobby for an extension of the tax credit , noting that “the massive hurdles that builders face in obtaining construction financing and appropriate appraisals on new homes could derail the fragile recovery in housing just as it is starting to take shape.”

A more detailed look at  the index since March 2008 is provided below.

Meanwhile, housing starts inched up just 0.5% in September to a seasonally-adjusted annual rate of 590,000 units, while building permits slipped by 1.2% to an annual rate of 573,000 units. 

The sluggish numbers last month were mostly due to sluggish starts and permits of multi-family units as single-family starts and permits gained 3.9% and 3.0%, respectively.

Still, the NAHB, in keeping with its lobbying efforts, said, “Builders are being extremely cautious right now in their efforts to maintain a modest inventory of new homes for sale.

“On top of the fact that it is nearly impossible to obtain construction financing for new units, there are widespread concerns about what will happen to demand with the expiration of the $8,000 first-time home buyer tax credit at the end of November.”