Eurozone inflation turns negative

The preliminary estimate for inflation in the 16-nation eurozone economy fell to –0.1% year-over-year in June from 0.0% in May.

Falling prices in Europe may complicate the European Central Bank’s job as it  has stubbornly held interest rates at 1.0% and most analysts expect no change at the July meeting.

Policymakers had expected inflation to briefly turn negative and it is doubtful they will be surprised by today’s report.  The ECB expects prices to edge up by the end of the year. But the central bank’s inflation target of “close to, but below 2%” leaves them plenty of room for more action.

In addition, their own forecasts suggest that an economic upturn won’t occur until 2010.

Please see ECB expert issues warning.

IMF to world: spend stimulus money

The IMF last Friday urged governments around the world to fully implement spending measures that have already been crafted to lift the global economy out of the worst recession in decades.

An IMF spokesman said, “Tentative signs are emerging that the rate of decline in global output is moderating and that financial conditions are improving.” But it's still too early to draw firm conclusions. "After all, the breadth and severity of the financial crisis and economic slowdown are the most serious experienced since the 1930s.”

An interesting statement in the report sheds some light on how little concrete action the Obama administration has taken in tackling the crisis.

The IMF said that payroll tax cuts had been implemented relatively quickly, but only $46 billion, or 11% of authorized spending measures, had taken place through mid-May, concentrated in health and human services.

That's peanuts when compared to a $14 trillion economy, and it highlights the lengthy spending process versus tax incentives.

The Fed has taken dramatic action, cutting rates to zero and offering to buy nearly $1.8 trillion in government securities. It's time for fiscal policy to take a more prominent role.

Japan showing signs of life

But employment lags

Just a few months ago, Japan's economy had come to a crashing halt as global demand dried up and a strong yen exacerbated an already bad situation. Companies responded by quickly slashing production, and GDP tumbled at an almost unheard of double-digit rate.

Fast-forward to June and suddenly the clouds are lifting on the economy, at least for the moment.

Yesterday's sizable jump in Japanese industrial production was followed up by the first increase in household spending in 16 months, while the manufacturing PMI is nearing 50.

Household spending increased by 0.3% versus a year ago, well ahead of expectations of a drop of over 1%. Most analysts credited the government's stimulus package, but after bottoming at -5.9% four months ago, the trend has been moving in the right direction.

In the meantime, Japan's PMI increased 1.6 points to 48.2, its best reading in over a year. The survey of manufacturers remains below the expansion-contraction line of 50 but has displayed marked improvement after bottoming at a wretched -29.6 in January.

The PMI is tracking industrial production higher as companies replenish depleted stockpiles. And the improvement bodes well for the Tankan survey out tomorrow, which is a closely-followed quarterly survey of business confidence.

However, as we get past this re-stocking cycle, continued growth in production will likely moderate unless demand in Europe and the US accelerates.

That brings to the jobless report. Like the US Japan has been wrestling with rising unemployment. The latest figures show the jobless rate rose from 5.0% to a five-year high of 5.2%.


Source: Bloomberg News

The jobs-to-applicant ratio fell to 0.44, the worst reading since the survey began in 1963, the Labor Ministry said.

IEA sees uncertainty in energy demand

The International Energy Agency said in its medium-term energy report that the global financial crisis has turned the economic landscape upside down, with huge implications for the oil and gas sector.

Depending upon what type of economic rebound we see around the world, the IEA report indicated that demand could increase between +0.4% and +1.4% annually after 2009.

Based on a worst case scenario, the Financial Times said OPEC spare capacity next year could reach a "healthy 7.67 million barrels per day or 8% of demand" versus last year's forecast of just 1.67 million barrels.

Despite the seemingly bearish report, crude prices are brushing aside the news and are higher. But if demand remains weak and excess capacity grows, prices could quickly hit a ceiling.

Japan manufacturing on the rebound

Preliminary data showed that industrial production in Japan jumped a sharp 5.9% in May, matching April's increase. Though behind the consensus estimate by about a percentage point, the rise was the third gain in a row, signaling Japan's industrial sector, which had been battered badly by falling demand around the world, is quickly improving.

The rebound has been sharp, per statistics provided by the Ministry of Economy, Trade and Industry, as production had been down an almost unfathomable

• 8.5% in November
• 9.8% in December
• 10.2% in January
• 9.4% in February

Note how quickly manufacturers in Japan responded to the rising yen and the global credit crunch last year.

Consumers still remain reluctant to spend, as evidenced by a 2.8% decline in retail sales versus a year ago, but it's looking more like a V-shaped recovery for the industrial sector as companies re-stock depleted inventories.

Jump in personal income ups savings

Personal income jumped 1.4% in May. A one-time $250 social security payment from the government stimulus program accounted 1.2 percentage points of the gain.

Spending increased a modest 0.3%, as rising consumer sentiment is still not translating into higher spending. Thus, the savings rate increased to 6.9%, the highest in 15 years.

Additional commentary is available at Examiner.com.

Greenspan worries about inflation

Former Fed Chairman Alan Greenspan opined in the Financial Times late yesterday that inflation will pose the greatest challenge to the global economy over the next few years. "Excess capacity is temporarily suppressing global prices," Greenspan said.

He added, "If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply."

Monetary policy always works with a lag. The difficulty is anticipating whether or not the huge amounts of economic stimulus already in the pipeline from the Fed and world central banks will be enough to lift the economy out of the current mess.

Given that signs are growing that we are near the end of the recession in the US, it appears that actions taken by the Fed are having the designed impact.

Although the debate as to when and how quickly to remove the monetary stimulus is raging among policymakers, I suspect that no one wants to be blamed for stomping on the green shoots that have begun to emerge.

And the Fed will probably err on the side of caution as it withdraws liquidity and starts raising rates. Note in its last two statement, the FOMC said it plans to keep the fed funds rate at low levels for "for an extended period."

Greenspan's easy monetary policy probably contributed to the current mess, but he provides a strong argument when it comes to his concerns about rising prices over the longer-term.

Japan core CPI sinks

Deflation may not be a problem in the US, but Japan could once again be seeing problems on the pricing front. The Japan's core Consumer Price Index, which removes fresh food, fell by 1.1% versus a year ago, compared to a 0.1% decline in April.

The world's second largest economy struggled with deflation in the early part of the decade following the economic stagnation that mushroomed after the bubbles burst in both the stock and real estate markets.

Many critics blame a slow response by the government and the Bank of Japan in the middle 1990s for the lost decade that followed. And falling prices this time around could undermine efforts by authorities to boost consumer spending.

The BoJ finally drove interest rates to zero and flooded the system with extra cash, but it was the economic recovery in the US and fast growth in China that finally pulled Japan out of a recession and enabled the central bank to end its policy of quantitative easing.

Fed Chief Ben Bernanke and other US policymakers are keenly aware of what happened to Japan and have been much quicker to react to the crisis in the US in hopes of avoiding a repeat at home.

Few changes from Fed

The Federal Reserve pretty much did a copy and paste from its late April statement as it put together the latest release following its two-day meeting.

This should not come as much of a surprise given that not much has happened in the economy that would warrant a shift in policy or a signal that a change is needed. See Fed meeting tops week's economic calendar.

I detail and analyze the statement at Examiner.com in my article, Fed slightly more upbeat, no changes to bond buys.

Michigan tops in unemployment rate

About three weeks after the government releases nonfarm payrolls and the unemployment rate for the prior month, the US Labor Department provides a state-by-state look at the jobless situation.

Not surprisingly, Michigan, with all the well-publicized auto-related problems it is dealing with, leads the list followed by Oregon, Rhode Island, and South Carolina.

States with the highest unemployment rates:

State                                            Jobless Rate in May

1. Michigan                                          14.1%
2. Oregon                                              12.4%
3. Rhode Island/South Carolina 12.1%
4. California                                         11.5%
5. Nevada                                              11.3%
6. North Carolina                               11.1%

States with the lowest unemployment rates:

1. North Dakota                                    4.4%
2. South Dakota/Wyoming              5.0%
3. Utah                                                     5.4%
4. Oklahoma/Montana                      6.3%
5. New Hampshire/New Mexico   6.5%
6. Louisiana                                           6.6%

United States = 9.4% in May

 

Michigan again reported the highest jobless rate, 14.1 percent in May. The states with the next
highest rates were Oregon, 12.4 percent; Rhode Island and South Carolina, 12.1 percent each;
California, 11.5 percent; Nevada, 11.3 percent; and North Carolina, 11.1 percent.

Germany's IFO Business Climate brightens

But improvement solely in expectations component

The IFO Business Climate Index in Germany, a closely-watched measure of business Confidence, increased from 84.3 in May to 85.9 in June, the highest reading since November.

The good news, however, was solely the result of an improvement in the future expectations component, which tempers the overall rise in enthusiasm as the current situation remains poor – see chart.

The survey of 7,000 businesses shows the worst recession in 60 years has not yet ended but the worst is probably over for Europe’s largest economy.

Though a bit confusing at first glance, I like the chart below because is reflects an easing of the recession in manufacturing.

Note the improvement from extremely lows levels in December and January but the economy is not yet in the ‘upswing’ category.

The IFO stands in stark contrast to the unbridled enthusiasm seen in the ZEW survey of institutional sentiment. See ZEW on upward trajectory.

Japan manufacturing sentiment shows sharp improvement

Sentiment among large manufacturers in Japan jumped from a record low of -66 three months ago to -13.2, according to a government survey. A reading below zero indicates more businesses are pessimistic about the outlook, but the sharp reversal suggests the worst recession since World War II is nearing an end.

Japan is the world's second-largest economy, and it is highly dependent upon exports. The steep drop in world demand has hit the economy hard, and the rise in the yen late last year exacerbated an already bad situation. But China's economy appears to be improving and imports into the Asian giant are benefiting its neighbors.

Additionally, the survey is signaling that the Bank of Japan's closely-followed Tankan survey of corporate confidence out on July 1 will also reflect gains in sentiment.

A look at housing and spending

There are several important economic events that will occur this week, including the Federal Reserve's two-day meeting, housing data, and consumer spending.

Because of the importance of the Fed's meeting, I've already put together a separate summary of the key points and will focus here on housing starts, existing home sales, and the consumer spending report.

Existing home sales (Tuesday) make up roughly 90% of the housing market and sales have held at steady, albeit at low levels over the past six months. Analysts anticipate a modest increase in May as the Pending Home Sales Index has shown signs of life recently.

Lower mortgage rates and the $8,000 tax credit for first-time home buyers have also contributed to the improved outlook. House prices, however, have yet to show signs of bottoming.

New home sales (Wednesday) have struggled a bit more because of the tough competition from foreclosures. But housing starts jumped in May and building permits suggest further improvement.

Although the Housing Market Index signaled that sentiment among homebuilders receded slightly in the latest month, the survey also shows sentiment is well off extremely low levels and a 3.6% rise in new home sales is forecast per Bloomberg.

Consumer spending out of Friday is expected to increase by 0.4% in May. Consumer spending accounts for 70% of total economic activity, and consumers have been bulking up on savings since economic activity crumbled late last year. An improvement is critical if the economy is to stabilize.

Falling natural gas prices may provide relief

Natural gas is a commodity that heats many homes across the United States and consumers have seen their heating bills jump over the past few years. Major hurricanes that have tracked across the Gulf of Mexico shut in supplies and caused prices to jump in late 2005, while the run-up in crude last year and the rush into all types of commodities caused prices to spike in 2008.


But as the chart by the Energy Information Administration reveals, prices have plummeted, signaling that next year's heating season could offer significant relief to homeowners and add to disposable income.

The recession is a good part of the reason but supplies are more than ample as producers continue to inject vast quantities of the colorless and odorless gas into underground storage tanks.

Working Gas in Underground Storage Compared with 5-Year Range
As you can see, storage is well above the average for this time a year amid weak industrial production and mild summer temperatures. Production from the giant natural gas field known as the Barnett Shale under Fort Worth, Texas has also played a role.

Economic data point to eventual improvement

The chart at the right provided by the Federal Reserve Bank of Philadelphia is the latest in a string of reports this week that shows a bottom in economic activity is near. See my analysis, Philly Fed Index paints brighter picture.

The Leading Index (also available at the link above) jumped for the second-straight month, while continuing jobless claims plunged.

Earlier in the week, we saw an unexpectedly steep rise in housing starts, and building permits also pointed toward a brighter future. I've said it before and I know it is a cliché. We aren't out of the woods yet, but we are approaching a clearing.

Jobless claims in very gradual downtrend

Weekly initial jobless claims inched up in the latest week and remain intolerably high.  Still, the trend is in the right direction and continuing claims plunged 148,000. I go into more detail at Examiner.com.

Where is China headed?

China's economy galloped ahead for much of the decade and gobbled up a sizable chunk of the world's raw materials, ending a 20-year deflationary cycle in commodity prices. When the US financial crisis erupted last September, fears of falling demand quickly pricked the speculative bubble and sent everything from silver to copper to oil down sharply in price.

There is now talk that China's economy will be among the first to emerge from the global recession, helping to lift developing economies in the region, while aiding countries dependent on commodities.

We are already seeing raw materials like copper, a key industrial metal, bounce off lows. See What can see glean from Dr. Copper. And that's a good sign for the global economy.

Furthermore, some of this buying appears to be coming from China, but there is also a speculative component that is anticipating renewed vigor late in the year, not just in China but also in the US.

That's why I found the Bloomberg article "Bubble of Belief" in China Economy Seen Bursting: Chart of the Day rather intriguing.

China is unlikely to return to its robust past if the US and other major economies remained mired in a recession because exports have been a solid driver of growth in prior years. But China continues to invest in infrastructure so it seems unlikely that China will sink into a severe recession.

Still, as pointed out on China Economy Watch, the Asian giant may just be stockpiling commodities and adding to manufacturing capacity - and doing this at a time when there is excess capacity around the world.

If the global economy experiences only a meek upswing over the next 6-12 months, Chinese demand for raw materials might quickly trail off, commodity deflation could reappear, and China's expansion may stall.

ECB warns on loan losses

Institutional sentiment in Germany may have improved markedly since late last year, but the June 2009 edition of the European Central Bank Financial Stability Review released yesterday paints a more cautious picture.

ECB Vice President Lucas Papademos said deterioration in the global economy as well as sizable downward revisions to growth forecasts have added to the "stresses on global and euro area financial systems."

He added that there have been increasing signs of an "adverse feedback loop between the real economy and the financial sector" which poses new challenges for the safeguarding of financial stability.

His remarks coincide with a report by ECB financial stability expert Dejan Krusec that I detailed last week at Examiner.com that problems may surface in 2010. See Problems may be brewing in Europe.

Eurozone policymakers were slow to react to the deteriorating economy last year. I hope they are more proactive this time around. And I hope that's not too much to ask for.

Germany optimism on upward trajectory

But are analysts getting ahead of themselves?

Many analysts eagerly await the release of a key measure of German institutional sentiment known as the ZEW Indictor of Economic Sentiment.

For June, the indicator increased by 13.7 points to 44.8 and is holding above the historical average of 26.3 points. In my opinion, there appears to be a disconnect due to the turmoil the German economy is still dealing with.

ZEW Indicator of Economic Sentiment for Germany

Rising, or maybe a better word “soaring,” sentiment among institutions is a welcome development.

But I have to caution that industrial production and incoming orders are not yet headed higher – Germany is oriented toward manufacturing and has been hit very hard by the drop in global demand – and most economists do not see an upturn in Europe until early next year.

Plus, sentiment bottomed out in October just as GDP was poised to drop at its worst pace on record. The ZEW missed that one.

Though the survey is well-respected and gets plenty of attention in the financial community, I think the analysts surveyed are getting a little carried away. I prefer the IFO Business Climate Index, which hit bottom in March.

Your opinions are welcome.

Separately, a look at today’s US economic data is available on my homepage at Examiner.com. A summary is available below.

BoJ ups assessment

The Bank of Japan kept its key lending rate at 0.10% as expected but raised its assessment of the economy for the second time this year.

Policymakers at the BoJ conceded that domestic demand has continued to weaken but overall conditions "have begun to stop worsening." The central bank added that production turned upward, and public investment has also increased.

In the coming months, the BoJ noted that Japan's economy is likely to show clearer evidence of leveling out over time. Meanwhile, financial conditions have generally remained tight, although there have been signs of improvement.

The recession in the US has eased but the nascent optimism emanating from Japan's central bank is probably coming from the modest pick up in China's economy.

Housing, production mixed while wholesale inflation recedes

Today's economic reports provided a mixed bag to those of us who have long ago grown weary of being pounded by news of the worst recession in decades. But I am heartened by the unexpectedly strong jump in housing starts for May.

Granted, a surge in the volatile multi-family sector underpinned construction, but there were modest gains in single-family starts. In addition, building permits improved, including a solid gain in permits for single-family homes. The $8,000 tax credit for first-time buyers appears to be having the desired effect.

The big drop in manufacturing was generally expected but helped to sully the upbeat housing number. Manufacturing is in the throes of a terrible recession (stating the obvious?) as global demand disappeared late last year, leaving factories idle all around the globe. But in order to get rid of the excess goods on hand, the steep drop in production is needed, painful as it may be. See Falling business inventories viewed in positive light.

Finally, I'd like to wrap up with the wholesale inflation report. It's clear that core producer price pressures, prices minus energy and food, continue to recede, and the headline number is falling due to the linger impact of last year's drop in oil prices.

With all the slack still in the economy, there is little to be concerned about regarding inflation, at least through the remainder of the year and probably well into next year.

Housing starts, building permits gain

Housing starts surprised to the upside, surging in May amid strength in multi-family construction; however, single-family homes also contributed to the strong month. A bottom? Maybe.

A more detailed look, Housing starts surge, is a available at Examiner.com.

Philly Fed typically upstages Empire

Today's sell-off on Wall Street was blamed by many on a modest and unexpected dip in the Empire Manufacturing Index. See Empire provides first look... below. I honestly cannot recall a time when the index has ever had this kind of impact on stocks.

Typically, the Street barely notices this first look at manufacturing for the current month because of its volatility and narrow scope. And the expectations portion of the index did improve.

I'll be more interested in the Philly Fed's Business Activity Index out on Thursday. If we get an unexpected dip in the survey of the mid-Atlantic region, it would suggest manufacturing has hit a bump in the road on the way to a recovery.

But it's important to remember that a bottoming in economic activity may not be a smooth process, and hiccups along the way are to be expected. It may also be signaling that a very gradual recovery, i.e., more of a U- or W-shaped recovery rather than a V, is going to develop. See L, W, U, V – the alphabet soup of economic recoveries.

That shouldn't come as a surprise given the ongoing problems in housing and banking.

Empire provides first look at manufacturing

I like taking a look at the Empire Manufacturing Index because it is the first glance and manufacturing in the current month.

However, the survey is considered to be near the low end of the “A List” of economic reports and typically does not have an impact on the stock and bond markets. Today may have just been one of those exceptions and contributed to the sell-off on Wall Street.

For a more detailed look, please see Empire manufacturing slackens on Examiner.com.

G8 looks to recovery, eventual withdrawal of stimulus

The meeting of the Group of Eight finance ministers took place earlier in the weekend and leaders acknowledged that they discussed the need to begin unwinding some of the extraordinary policy measures that were taken in response to the dire situation late last year in the financial markets.

Of course, leaders didn't give the all-clear signal, and they believe unemployment will continue to rise and "significant risks remain." But they were quick to point out that signs of stability are emerging, including "a recovery of stock markets, a decline in interest rate spreads, and improved business and consumer confidence."

Recent weakness in the dollar and rising US Treasury yields were left out of the communique, and only a passing mention was made on rising commodity prices. withdrawal

The latest on mortgage rates

It’s not pretty. Mortgage rates have jumped in recent weeks, cooling the refi boom and putting Ben Bernanke’s plan to reignite the housing market in danger. Blame the rise in the yield on the ten-year Treasury bond.

A more detailed look at the how and why of mortgage rates is available in my post, What is behind the recent rise in mortgage rates, at Examiner.com.

Import prices rise again

Rising at the fastest pace since July 2008, the Import Price Index rose for the third-consecutive month, increasing 1.3% in May as the cost of petroleum continues to rise.

Because of the huge drop in oil prices versus a year ago, the index is down 17.6% year-over-year but the downward trend has probably run its course.

If you pull out the price of oil flowing into the US, prices edged up 0.2%. The first rise in almost a year was mostly the result of an increase in the cost of industrial supplies, and that corresponds to recent gains in commodity prices.

It's unlikely we will see a jump in imported inflation simply because there is too much excess industrial capacity around the world. Put more simply, if a businesses overseas tries to raise prices, there are several that can step in and easily undercut him.

On the flip side, the data are the latest in a string of economic reports that signal deflation is unlikely to overwhelm the economy. See The Deflation Monster. And the weakness in the dollar should also underpin prices.

Where deflation could become a problem

I don't believe deflation will become an issue in the US (see The Deflation Monster), especially since the economy is expected to gradually begin improving later in the year. Besides crude oil prices have doubled since the low point just a few months ago, and most major commodities have rebounded modestly.

But I spotted this interesting piece in the Wall Street Journal entitled, Risk of Deflation is Rising in Ireland. If deflation does take hold, consumers may begin to hold off on purchases and exacerbate an already bad situation.


Source: WSJ

ECB expert issues warning

The European Central Bank is worried about another economic crisis next year if the economy does not recover at a quick pace. The central bank's financial stability expert said it monitors 25 strategically important institutions, and the banks have the capital to cover losses in 2009, but next year is problematic depending on the strength of the recovery.

A rapid "V-shaped recovery" would alleviate much of the worry, he said, but a slow rebound, or a U-shaped recovery could cause rising problems and new defaults on the continent in 2010. For a look at different types of economic recoveries, see my post L, W, U, V - the alphabet soup of recoveries.

The ECB is currently expects GDP to decline in the eurozone for the remainder of the year before slowly rising sometime next year, so I have to make the assumption the ECB is worried about another wave of problems sometime in the next 9-12 months.

The IMF weighed in recently, imploring policymakers to clean up banks in Europe. It appears central bankers are listening and taking the issues seriously. See post IMF sees signs of improvement but banks must be cleansed.

Unfortunately, central bankers in Europe felt they were immune from the subprime crisis in the US and actually raised interest rates in July 2008 amid rising inflation and were caught flat-footed by the Lehman debacle.

I provide a little bit different look at Examiner.com.

Falling business inventories viewed in positive light

Business inventories in the US fell 1.1% in April to $1.4 trillion, the eighth consecutive monthly drop and slightly larger than expected. Sales were down a more modest 0.3%, and the inventory-to-sales ratio, or how many months it would take businesses to liquidate all stockpiles, fell from 1.44 to 1.43.


The inventory-to-sales ratio is an important indicator that economists look at because it shows how many goods are on hand based on sales, i.e., what's in the warehouse. Late last year, sales virtually fell off of a cliff and inventories soared, pushing the ratio sharply higher.

Companies responded by quickly slashing output as industrial production fell at an annualized rate of 20% in 1Q.

Falling inventories are apart of the GDP equation, and a drop will pressure the economy while rising inventories add to GDP growth. However, at this point in the business cycle, the decline in stockpiles is viewed positively because it is being seen as a sign that companies are whittling away at the excess number of goods on hand.

As sales slowly rebound, which I anticipate later in the year, inventories should drop to levels considered more normal by businesses. And we are likely to see further declines in inventories as companies pare back on bloated levels. But companies will get a handle on inventories, and an eventual rise in sales will eventually lift production.

Meanwhile, for a look at today's weekly claims report and retail sales, please see my homepage at Examiner.com.

Japan GDP revised upward, still awful

Improvement may be forthcoming

The Japanese government said that GDP in 1Q fell at an annual pace of 14.2%, versus the originally reported drop of 15.2%. The government also said 4Q was revised to -13.5% from -14.4%. Hence, 1Q was the largest drop on record.

Japan's export-dependent economy has been hit very hard by falling demand around the world. Difficulties in the global economy have been compounded by the strong yen, which can make exports more expensive.

Nonetheless, recent indicators are suggesting some stability, and expectations that China's economy is expanding at a modest pace may lend some support to Japan's beleaguered economy.

Ten-year Treasury yield just under 4%

The government announced the sale of $19 billion in ten-year Treasury bonds today at a rate of 3.99%, while Russia's central bank is reportedly considering a modest move away from holding its reserves in dollars.

As a result bond prices continued on their downward path and yields pushed ever higher, which threatens to stifle the housing market that has been scraping along at very low levels. See Rising Mortgage Rates May Add to Housing Woes.

I've mentioned before how Fed Chief Ben Bernanke has committed over $1 trillion to buy agency-backed securities and another $300 billion in longer-term Treasuries in order to squeeze the risk premium out of the system - that is, narrow the spread between US Treasuries and lending among major financial institutions and thereby lowering borrowing costs.

His plan did temporarily bring down yields on government bonds and spreads have narrowed. See see Credit markets on the mend. But the so-called "bond vigilantes" are in open revolt over the massive federal budget deficit and future worries about inflation. And the spike in yields is playing havoc with homeowners who had planned to refinance mortgages, and it could keep some potential home buyers on the sidelines. See Higher Mortgage Rates Dampen Refi Enthusiasm.

Rising gasoline prices won’t derail a recovery

It doesn’t take a colorful graph provided by the Energy Information Administration to tell the average motorist that gasoline prices have been rising since the beginning of the year, but the chart below does give us a concise look at how prices have surged in recent months.

As of June 8, 2009, regular gasoline averaged $2.62 per gallon. That’s up 10 cents from a week ago but down $1.42 versus one year ago.

The big drop from last year’s peak of over $4 per gallon shouldn’t be dismissed and is probably helping some at the margin because it increases disposable income, but the rise from last year’s low and further gains are unlikely to snuff out any burgeoning recovery.

Let me explain. Economists have said that for every penny increase or decrease in gasoline prices, the nation’s gasoline bill will rise or fall by $1 billion.

So it’s safe to say that falling prices act like a tax cut just as rising prices act like a tax increase.

At the margin higher prices could have an impact on discount retailers that cater to lower income folks and those looking for work. When prices were rising earlier in the decade, we did get comments from some of these companies that higher prices at the pump did impact sales. Furthermore, the economy is more fragile today.

However, the government reported that personal spending in April totaled $10.3 trillion dollars. And nominal GDP exceeds $14 trillion.

Higher prices are definitely a big nuisance since I believe we all want to pay less when we fill up our autos. But when tens of billions of dollars are compared to $14 trillion, we’re looking at less than 1% of total GDP.

For another look at rising oil prices, please see Oil Pops Above $71 per Barrel on Examiner.com.

Trade deficit in the US widens

The US trade deficit increased from an upwardly-revised $28.5 billion in March to $29.2 billion in April, topping the consensus forecast per Bloomberg of $28.5 billion.

The cause was simple – April exports fell $2.8 billion, while imports were down by $2.2 billion.

There’s not a whole lot to say about this report except that the decrease in both imports and exports reflected the weakness in both the US and global economies in April.

Industrial supplies and materials as well as capital goods accounted for the lion’s share of falling US sales overseas, which underscores worldwide weakness.

The average price of imported oil increased from $41.36 per barrel in March to $46.60 in the latest month, and that rise was reflected in a $1billion rise in the nation’s bill to import oil.

The tremendous drop in crude prices has significantly dented the US trade gap, but oil prices are on the rebound, and unless we see significant economic gains abroad without a corresponding improvement in the US economy – that’s very unlikely, the best news on the trade deficit may be behind us.

IMF sees signs of improvement but banking must be cleansed

The International Monetary Fund (IMF) said today that policymakers must take decisive action on behalf of the financial sector in order to put the eurozone economy on a self-sustaining path toward growth.

Tentative signs of improvement have yet to “germinate into a recovery,” the IMF said. A key missing element has been a “proactive strategy to deal with a weakened financial system, including a review of capital needs to manage the recession, a cleansing of the financial system of its impaired assets, and a restructuring of weakened institutions.”

The IMF gave three reasons why a thorough cleaning of the financial system is in order:

• monetary and fiscal policies will not be as effective as they could be in supporting demand
• there continues to be a significant risk of a further negative feedback loop with the real economy
• the European financial system could well remain on a drip-feed of taxpayers’ money for a long time to come. Private investors will not step in, and constraints associated with government intervention will reduce overall efficiency.

It also applauded recent actions taken by the European Central Bank, which stands in sharp contrast to German Chancellor Angela Merkel who lashed out at the ECB for announcing its intent to buy 60 billion euros in covered bonds. See ECB Takes New Action.

Europe's in the grips of the worst recession in 60 years, the ECB fell well behind the cruve before taking more decisive action, and Merkel offers up an unprecedented attack on the central bank!

Apple slashes iPhone price, pressures rivals

Apple announced late yesterday that it is cutting the price of its popular iPhone to $99 and will introduce two new iPhones priced at $199 and $299. Dubbed the 3GS because of added speed, the new phones will have memory of 16GB or 32GB.

The move could put pressure on rivals such as Palm and Nokia, analysts said, and it could also broaden the appeal because the lower price will probably appeal to cash-strapped consumers. Apple has consistently exceeded it profit targets and has managed to grow profits even in thsi recession (see The Sweet Taste of Apple).

Germany industrial production weakens

Germany is still not out of the woods yet as preliminary data showed that industrial production in Europe’s largest economy fell 1.9% in April following a small rise in March.

Germany’s economy has been hard hit by the drop in worldwide demand since activity is heavily dependent on exports. The pace of decline has slowed and the government does believe demand is stabilizing for industrial goods.

The country’s central bank said on Friday that it expects the economy to contract by 6.2% in 2009, the worst reading since WWII and 0.2 percentage points below the prior forecast.

However, the downward pressure is expected to ease later during year year, and an upturn in Germany won't likely occur until 2010, the Bundesbank said.

Interesting facts about oil

Most people know that the US is the world’s largest consumer of crude oil.  But did you know that the US is the world’s third-largest oil producer, with production running at a little over 5 million barrels per day? Interestingly, the US produces 10% of the world’s petroleum and consumes 24%. Saudi Arabia and Russia are the top producers.

Consumption, Production, and Import Trends (1950-2007)

You may also be surprised to find out that almost 50% of US oil and petroleum products imports came from the Western Hemisphere during 2006. We imported only 16% of our crude oil and petroleum products from the Persian Gulf countries of Bahrain, Iran, Iraq, Kuwait, Qatar, Saudi Arabia, and United Arab Emirates. That debunks the myth that all US imports come from unstable OPEC nations.

In fact the top five suppliers of petroleum products in 2007 were:

• Canada (18.2%)
• Mexico (11.4%)
• Saudi Arabia (11.0%)
• Venezuela (10.1%)
• Nigeria (8.4%)

The top two are very stable, while Nigeria has been plagued by violence in recent years.  Hugo Chavez has been a rhetorical thorn in the side over the past decade, but he likely needs us right now more than we need his oil.

Net imports still account for 58% of our supply, but I’m not trying to suggest we shouldn’t try to narrow that gap.  If supplies from overseas are disrupted, price volatility would soar, and it would likely cause shortages that would have to be alleviated by the Strategic Petroleum Reserve.

But US dependence on foreign imports is projected to fall from 58% in 2007 to 41% by 2030. Reason – the increase in US crude production in the Gulf of Mexico and elsewhere, combined with increasing biofuel and coal-to-liquids (CTL) production, is expected to reduce the need for imports over the longer term.

Source: Energy Information Administration

Obama attempts to jump-start job creation

Nonfarm payrolls fell less than expected in May but the unemployment rate surged to a 26-year high of 9.4% last month, igniting criticism that President Barack Obama's recently-passed stimulus package is not doing enough to alleviate growing unemployment lines.

The Roadmap to Recovery as it is called is designed to save or create 600,000 jobs this summer, including 125,000 jobs for teenagers. Many of these positions are in education, health services, law enforcement, and infrastructure.

Republicans were quick to express skepticism, noting that the projections appear to be rosy. From my vantage point, the stimulus spending is far too narrow. Let's face it, if you are over 20 years old and not in construction, law enforcement or health care, the extra dollars won't be very helpful.

Credit markets on the mend

The latest piece of evidence to show that credit conditions are on the mend came in this piece by Bloomberg News entitled, ‘Fierce Rally’ Under Way for Loan CDOs, Morgan Stanley Says.

The article states,

“CLOs are a type of collateralized debt obligation that pool high-yield, high-risk, or junk, loans and slice them into securities of varying risk and return. Pieces graded AA, the third highest-level of investment grade, rose from 23 cents on the dollar to 47 cents in the past month.” Bloomberg cited a report by Morgan Stanley.

The three-month LIBOR rate has fallen dramatically, and the TED spread (chart below) and the Libor-OIS spread (both measures of risk), have narrowed considerably. See Credit Markets are Finally Melting.

The three month LIBOR defines the rate banks lend to each other for three months, while the TED spread is the difference between LIBOR and the three-month T-bill. OIS (Overnight Index Swaps) are a little bit more complex but I located a great definition for those looking for the details at Learning Markets.

How does this measure risk?

The re-emergence in risk-taking is not only a clear indication that confidence is returning to the credit markets, but an signal that a Lehman style debacle or AIG bailout isn’t going to happen again.

Last September, Fannie Mae and Freddie Mac were nationalized, AIG was bailed out, and Lehman was allowed to disintegrate. Fear in the credit markets grew exponentially and a flight-to-quality ensued, driving T-bill yields to zero.

Even the normally safe three-month Eurodollar contracts, which are priced by the three-month LIBOR, were dumped as inter-bank lending ground to a halt. Funds sought all but the safest assets, such as US Treasuries, sending spreads into the stratosphere.

As the atmosphere has returned to a sense of normalcy and most traders no longer anticipate a failure of a major institution, spreads are narrowing and lending among banks is returning.

Rate hike in the near term?

The improvement in financial markets is likely to underpin economic activity. In fact, fed funds future are now pricing in a modest chance of a rate increase later this year.

In my view, we need to see an improvement in employment and positive growth in the US before the Fed will start raising rates. Bernanke and Co. do not want to be accused of short-circuiting an economic recovery by stepping on the brakes too soon.

L, W, U, V – the alphabet soup of economic recoveries

The question I’ve been hearing from economists is what type of economic recovery will we experience when the worst recession since the 1930s is finally put to rest. And I find it interesting that the academics use letters of the alphabet - L, W, U, V - to describe the shape of economic activity when we come out of an economic slump.

Let’s look at the 'L’ first. An L shaped recovery is almost no recovery at all. The recession comes to an end, but instead of seeing improvement, the economy remains stuck near the bottom.

Fortunately, this type of recovery is something we have not experienced in the US, but the Japanese government was slow to react in the wake of the collapse in real estate in the early 1990s, and a lost decade of growth followed.

Policymakers in the US are keenly aware of what happened across the Pacific and are doing their utmost to avoid a repeat at home. I believe an L shaped recovery is unlikely.

That leaves us with the V, U, and W. The US economy has typically rebounded sharply following steep recessions – the V shaped bottom. See Steep Recessions and Subsequent Recoveries. Interest rates fall, tax cuts take effect, and pent up demand is unleashed after a bottom. This was definitely the case following the short but severe drop in output in 1958.

But we saw a U shaped recovery in the early 1990s and at the beginning of this decade following relatively-mild recessions. And the economy traced a W during the 1981-82 recession. This is sometimes called a “double-dip” recession because activity improves, then slips, before finally embarking on an upward path. When growth eventually picked up, the recovery was robust.

Despite the severity of this recession, which increases the odds of a V-shaped expansion, housing is still struggling and banks continue to deal with bad debt.

On the other hand, consumer confidence is rising, credit markets have improved markedly, and counter-party risk is receding. If housing corrects itself, the V may play out. Without a solid foundation in housing, a U or W seems more likely.

Dollar jumps following employment data

The US dollar Index - a measure of performance against a basket of six major currencies - rose more than 1.6% today after the smaller-than-expected drop in nonfarm payrolls raised hopes that that the recession is easing and a turnaround in the economy may be imminent.

The strength in the dollar hit the price of gold, which lost $20 to $963. And crude, which has benefited from expectations that the economy is improving and recent weakness in the US currency, fell modestly.

However, oil was down less than $0.50 per barrel, and in my view, that suggests the recent rise in oil prices has less to do with the falling dollar, as some proclaim, and more to do with speculators that seem intent on piling back into crude amid signs the global economy will soon bottom.

Why this bull may have legs

Stocks have been crushed over the past year and half, leaving many of us to lick our wounds as the highly-touted and closely-followed Dow Jones Industrial Average of 30 stocks gave up more than 50% from its late 2007 peak to the recent low 6,440 in early March.

But a recovery in excess of 35% in just three months has been nothing short of astounding as investors begin to anticipate tangible signs of an economic recovery.

But is the rally for real or will we re-test the lows? I spotted this article, New bull run called by tracker of Dow's historical trends, on Marketwatch.com that suggests what we are seeing is the real thing. The surge over the past three months

"is second only to the post-Depression bull run, with odds favoring a further rise during the next three months, one strategist said. 'I say this with the utmost confidence and my fingers tightly crossed: This is the start of a new bull run,' said Hugh Johnson, chairman of Johnson Illington Advisors"

Going back to 1900, Johnson counts 18 surges of 20% or more in any given quarter. I must point out that according to The Economist, there were three rallies in the great bear market of the early 1930s that produced 20% gains that were then followed by new lows.

But I feel that Kate Gibson's piece expresses the growing optimism that the worst recession in over two generations will soon come to an end.

Today's employment report and the smaller-than-expected job loss is signaling a turnaround is near. See Nonfarm payrolls drop 345,000, Unemployment rises to 9.4% and Nonfarm payrolls vs. the unemployment rate.

Nonfarm payrolls vs. the unemployment rate

Most measures of the economy have been showing that the recession is easing, but today’s much smaller-than-expected 345,000 in nonfarm payrolls is the clearest sign yet that the economy is nearing a bottom.

Despite the relatively good news on payrolls,  unemployment jumped from 8.9% to 9.4%.  It seems like there is a disconnect between the two.

First, as I explained on my post on Examiner.com, Nonfarm payrolls drop 345,000, unemployment rate up to 9.4%, there are two separate surveys that measure nonfarm payrolls and the unemployment rate.

So let’s look at how the unemployment rate is calculated. Unlike the establishment survey, which focuses on companies and produces nonfarm payrolls, the household survey, as the name suggests, looks at households and generates the unemployment rate.

Unemployment per the household survey fell by 437,000 to a total of 140.6 million.  Not too much of a discrepancy here.  But unlike nonfarm payrolls, the unemployment rate looks at the total labor force, which increased by 350,000 to 155.1 million.

The difference, or 14.5 million, gives us the total number of unemployed.  Divide 14.5 million into 155.1 million and you come up with 9.4%.  So you  can see how a rise in the labor force, the bottom number in the math equation, affects the jobless rate.

If the labor force had remained unchanged, the unemployment rate would have risen two ticks to 9.1%.

Employment  trends

I don’t want to discount what’s happened in the labor market, and workers have felt the brunt of the recession.  Companies have shed 6 million jobs, the worst on record, and when you look at it based on a percentage drop from the peak, job losses have easily exceeded what happened in the steep recessions of 1974-75 and 1981-82. 

The severity of the current recession is only matched by the swift decline in payrolls in the short but nasty 1958 slump, but it’s not close to the 10% drop in payrolls that occurred just after World War II ended when the troops started coming home from overseas.

Productivity, unit labor costs or why inflation is sticky

It turns out that nonfarm productivity advanced at an annual rate of 1.6% in 1Q. That compares favorably to the initial report of a 0.8% rise and the forecast per Bloomberg News of 1.2%. Productivity has gradually trended lower because businesses have not been able to reduce hours worked as quickly as cutting back on output.

In 1Q, output tumbled by 7.6%, and hours worked fell 9.0%, the fastest pace in over 30 years. Do the math and you come up with 1.6%.

Let’s look at unit labor costs. Unit labor costs rose at an annual rate of 3.0% in 1Q as hourly compensation increased by 4.6%. Again, it’s simple arithmetic. 4.6 minus 1.6 (productivity) brings us to 3.0.

For many businesses, labor is the most expensive input. In good economic times, companies may find it difficult to find qualified employees and will bid up salaries in order to retain and acquire good workers. The pinch to the profit margin is usually resolved by raising prices. And when demand is strong, firms are typically able to make price increases stick.

So what’s going on? Business is terrible but unit labor costs are in a gradual upward trend. Companies may be shedding employees at a near record pace (remember, hours factor into productivity), but they apparently are not cutting back so quickly as to significantly boost productivity and bring down unit labor costs.

The apparent result, coupled with the lingering effect of last year’s surge in commodity prices, is a rate of core inflation, prices less food and energy, that is holding up near the top end of the Fed’s implied range of 1-2%.

ECB holds, sees eventual recovery

The European Central Bank kept is key interest rate at 1%, noting that economic activity over the remainder of this year is expected to decline "at much less negative rates." After a period of stabilization, "positive quarterly growth rates" are expected by mid-2010. The Bank of England kept its main lending rate at 0.50%.

The always-inflation-vigilant ECB did concede, however, that it sees higher unemployment in the coming months and inflation expectations are expected to remain firmly anchored (so why not cut again?). But the central bank still believes risk to the outlook are balanced.

Given the swift decline in eurozone economic activity, the central bank fell far behind the curve in an effort to fight inflation that no longer existed. The eurozone is the world’s second largest economy (Japan is number two when considering output on a nation-by-nation basis) and an improvement would bolster US exports.

Of course, it’s a two-way street, and a stronger US economy would also support Europe, especially Germany’s export-dependent economy.

Meanwhile, the 60 billion euro purchase program for covered bonds announced in May will begin in July, according to ECB President Jean-Claude Trichet, and will last until June 2010. The bank sure is taking its time.

Jobless claims hold in steady trend

 Weekly jobless claims fell just 4,000 in the latest week t0 621,000 and have been holding above 600,000 since the end of January.  There have been no signs of an acceleration, in fact, continuing claims fell for the first time since January, declining 15,000 to 6.74 million. However, claims haven’t been falling either as firms continue to shed payrolls.

There is not a one-to-one correlation, but we are likely to see another big decline in nonfarm payrolls for May when the data are released tomorrow given the steady number of weekly claims over the last month.

Bernanke worries about deficits

Fed Chairman Ben Bernanke discussed the economic outlook before House Committee this morning. He conceded that the unemployment rate is likely to keep rising for a while but also believes the worst is past. I detail some of his remarks in my article, Fed Chief Bernanke Believes Worst is Over.

In this post, I wanted to key in on one of his final remarks. Given that the recession has drastically reduced revenues at a time when government spending is soaring, the federal deficit has exploded.

The current administration sees red ink of:

• $1.8 trillion in fiscal 2009
• $1.3 trillion in fiscal 2010
• $900 billion in fiscal 2011

Let's do the math: $4 trillion in just three years! That's sobering and leaves one in a daze as it seems incomprehensible. Sadly, it's not.

Bernanke said this will take the ratio of federal debt held by the public to nominal GDP from about 40% before the onset of the financial crisis to about 70% in 2011. These developments would leave the debt-to-GDP ratio at its highest level since the early 1950s, the years following the massive debt buildup during World War II.

Keep in mind that after WWII, Social Security was still in its infancy, and we did not have the massive social programs that are now in place. In addition, universal health coverage is looming without a clear way to pay for it.

Bernanke did specifically mentioned Social Security and Medicare and warned, "With the ratio of debt to GDP already elevated, we will not be able to continue borrowing indefinitely to meet these demands."

Let me repeat: We will not be able to continue borrowing indefinitely.

The Fed, along with central banks around the world, were able to avert a financial catastrophe late last year. But the problem now is more like a slow boil. We know where we're headed and action on the spending front must be taken.

Recognizing that both political parties have done a poor job holding the line on government spending, I must ask, "Where are all the political pundits who decried the 'massive' Bush deficit's now?"

Any comments are appreciated.

ISM services post small rise

The Institute for Supply Management releases two major reports each month. The first is a look at conditions in the manufacturing sector, and the one I'll talk about today and the one released this morning looks at activity in the broad-based service sector.

The Non-Manufacturing ISM Report On Business increased from 43.7 in April to 44.0 in May and remains in a gradual uptrend. A reading below 50 suggests the service sector is still contracting but the trend is signaling that the pace of the recession is easing. Analysts according to Bloomberg had expected 45.0 so today’s small increase is a little disappointing.

New orders and business activity actually worsened, and though still below 50, prices paid was a key contributor to May’s rise, registering the largest increase among the subcomponents - 40.0 to 46.9. I’m still not looking for a burst of inflation, but disinflation (falling rates of inflation), which contrasts with deflation (actual prices declines), seems to have leveled off.

Gains since November of last year signal that the worst of the steep declines in activity are over; however, at this time, any economic recovery is likely to be slow. Although steep recessions in past years have been followed by strong recoveries, thus far, we are probably not looking at a ‘V’ shaped recovery, but something more like a ‘U’ or worse, a ‘W’ shaped expansion.

Strong gains in housing are still needed in order to put a firm foundation under economic activity. For a look at mortgage applications and housing data today, please see my home page at Examiner.com.

Pending home sales highest since September

The Pending Home Sales Index measures housing contract activity. It is based on signed real estate contracts for existing single-family homes, condos and co-ops.  A signed contract is not counted as a sale until the transaction closes. Therefore, it is considered a leading indicator of housing activity.

In April, the index jumped 6.7% to 90.3, the highest reading since September and the third monthly increase.  Moreover, pending home sales are up 3.2% versus a year ago.

The data shows that low interest rates and the $8,000 tax credit for new home buyers have sparked interest in the residential housing market. 

A recovery in housing sales as well as stabilization in prices are a key ingredient in the recipe for an ongoing economic recovery.  I would still like to see a sustained improvement in the Purchase Index from the Mortgage Bankers Association, but today’s report is good news.

One final point, note how pending home sales were recovering in 2008 and peaked in August, the month prior to the blow up in the credit markets.  You can clearly see how the credit freeze and the subsequent demise of confidence sent potential homebuyers scurrying for cover.

Reserve Bank of Australia sees stabilization

The Reserve Bank of Australia (RBA) left its cash rate unchanged at a record low of 3% as expected. The RBA noted in its statement that evidence has continued to emerge that the global economy is stabilizing, after a sharp contraction during the December and March quarters.

Australia's central bank remarked that considerable policy stimulus in most countries is helping to contain the downturn, and should support an eventual recovery.

The turnaround is "clearest in China" and some emerging countries, the RBA said, but a recovery in the major countries is likely to take longer to begin and be slower when it does occur. Australia also indicated that credit remains tight and confidence is fragile but prospects are being helped by better conditions in global financial markets.

Monetary policy has been eased "significantly but the RBA did not rule out further rate cuts.

Central bankers in Australia have cut interest rates by 425 basis points (4.25 percentage points) since September in order to mitigate the impact of the global downturn. The country is dependent on commodities, and subsequently, has not been immune from the steep downturn in prices following over 15 years of an expanding economy.

The RBA also helped to confirm that China's economy is displaying signs of leading Asia out of the nastiest recession in decades. Australia has forged closer economic ties with China, which has been devouring much of the world's commodities in recent years.

Capex weakens

Here's a interesting statistic I ran into while doing a little bit of research. The Equipment Leasing and Finance Association’s (ELFA) Monthly Leasing and Finance Index (MLFI-25), which reports economic activity for the $650 billion equipment finance sector, showed overall new business volume for April declined by 42.5% when compared to the same period in 2008.

Month-to-month volume fell by 12.8% in April. The association said that tight credit and the recession continue to impede new business volume, but April trends offer some reason for optimism.

Although capital spending makes up a much smaller percentage of GDP, it is a key driver of business cycles in the US. During economic expansions, business spending accelerates as companies invest to satisfy demand for products, and capex helps to drive the cycle. Conversely, when economic times become more difficult, companies slash outlays, deepening an ongoing recession.

ELFA said this is the only index that reflects capex, or the volume of commercial equipment financed in the US.

ISM slowly improves

As today’s bankruptcy filing by GM looms large in the news, I wanted to take a moment to discuss today’s report on manufacturing. The closely-followed ISM Manufacturing Index contracted at a slower pace for the fifth-consecutive month and rose from 40.1 in April to 42.8 in May. A reading of 50 marks the line between expansion and contraction.

What is particularly pleasing, in my view and another sign the economy is near a bottom, is a rise in new orders from 47.2 to 51.1, the first increase above 50 in 17 months.

Production and exports contracted at a slower pace but employment continues to languish, remaining nearly unchanged at 34.3. Unfortunately, improvement in the labor market lags a recovery.

Inflation still isn’t an issue but I believe it’s noteworthy to point out that the prices paid component rose from 32.0 to 43.5. One has to believe the bond market is paying close attention given recent weakness (Bailing Out of Bonds). The subcomponent had bottomed below 20 last year.

The contraction in manufacturing has been particularly swift, with industrial production falling at an annual pace of 20% in the first three months of 2009 as demand around the world collapsed. As inventories shrink and slowly lineup with demand, we should continue to see incremental improvements in manufacturing.

Stocks are reacting favorably as investors pile into stocks and ignore news of GM's Chapter 11 filing, which had already been discounted.

Consumers sock funds into savings

Personal income in April unexpectedly jumped 0.5% due to one-time factors, but spending fell 0.1%, underscoring nervousness among consumers. As a result, the savings rate improved from 4.5% to 5.7%.

One thing that bothers me just a little was a 0.3% rise in the core Personal Consumption Expenditures Index - a broad measure of inflation that excludes food and energy. With GDP tumbling at its fastest pace since 1958 and demand in hibernation, you would think inflation would be virtually nonexistent. Although the pricing data suggest we are stepping back from the threat of deflation (Deflation Monster), we don't want to see rising inflation as an expected recovery begins later this year.

I'm guessing that the lingering impact from high commodity prices last year is still affecting the price data. And since labor costs - the largest cost for most businesses - are barely rising, the bump we saw in April is likely to be temporary.

Confidence vs. spending

Consumer confidence has been improving but rising sentiment is not yet showing up in spending. If you look at the latest survey from the Conference Board, which measured sentiment in May (spending data is for April), you'll see that the improvement in confidence is occurring because many expect the economy to pick up later in the year.

The present situation showed little improvement because consumers are still worried about their jobs and home prices remain in a declining trend. Consequently, spending remains lackluster.