Strong Chicago PMI, drop in jobless claims below 400,000 point to upbeat start to 2011

The Chicago PMI, which measure activity among manufacturers in the Midwest, jumped from 62.5 in November to 68.6 in December, the best showing since July 1988 and the fourth month in a row the survey detected accelerating activity.

A reading of 50 suggests manufacturing activity in the region is neither expanding nor contracting.



Adding to the very strong report, production and new orders, which rose to a very impressive 74.0 and 73.6, respectively, now stand at their highest levels in over five years, while order backlogged are surging.

Further, employment also touched a five year high, while prices paid increased from 70.7 to 78.2, signaling that manufacturers are being forced to paid higher prices for raw materials amid improving worldwide demand.

Comments from some of those survey also paint a brighter 2011 and include :

1. 2010 was a very, very good year, 2011 looks just as strong thru Q1! 
2. The level of business keeps increasing and the resources to handle are not available.
3. Our backlog is increasing. Supplier lead times are still too long.
4. Employee turnover is starting to increase, this along with continued downsizing and increased outsourcing is driving consultant hiring.
5. Lending market slowly thawing but only for strong (financially) borrowers. Weak borrowers are still finding it nearly impossible to find a competitive source of reliable funding.

No doubt about it, the Chicago PMI tends to be a bit volatile when compared to the ISM Manufacturing Index, which takes a snapshot of the national picture.  But with the Philly Fed Business Activity Index reaching a six-year high in December, along with strong numbers from Chicago, it looks as if manufacturing is growing nicely and is set to support the broadening recovery.

Jobless claims finally tumbled below 400,000

In the meantime, weekly initial jobless claims fell a steep 34,000 to 388,000, the best reading since July 2008.  The 4-week moving average dropped a sizable 12,500 to 414,000.  I provide details at Examiner.com.



Difficulties in adjusting for seasonality, especially during the year-end holidays, may be responsible for the unexpectedly large decline; however, Bloomberg News reported that the Labor Department believes the data are good, and it was able to accurately adjust for seasonal variations.

If this proves to be true, then the drop below 400,000 is significant and is one of the strongest signals yet that economic activity is picking up.  Moreover, it suggest that an improving labor market may not be far behind.

Consequently, the new year may finally offer some much needed economic relief to the many who grew weary of the recession and the slow recovery long ago.

Consumer confidence surveys diverge

The Consumer Confidence Index, which is compiled by the Conference Board, unexpectedly fell in December, dropping 1.8 points to 52.5.  Details and a more formal look are available at Examiner – Consumer confidence unexpectedly sags.

Despite the recent but modest drop in weekly jobless claims, improving retail sales and strength in stocks, consumer confidence has been stuck in a very narrow range since June, per the Conference Board’s survey, and there are few signs confidence is about ready to emerge from its funk (see chart below).

Worse, the index is far below where it stood in December 2007 – 90.6 – when the recession officially began.



Contrast the Conference Board’s survey with the one provided by the University of Michigan (see second chart below).

Consumer sentiment was impacted by the summer slowdown and fears the economy might be set to slip back into a double-dip recession.  But when growth resumed, sentiment also improved.

Further, at 74.5, it appears poised to top the pre-recession level of 75.5.



So why the divergence? Methodology seems to give us a clue.

Although the University of Michigan does not offer specifics on the job market, it did say December’s rise “was due to improved employment expectations that made consumers more willing to spend and adopt more favorable prospects for the overall economy.

"Consumers reported much more favorable news about recent changes in the job situation, and more frequently expected the unemployment rate to decline during the year ahead.”

Compare that relatively rosy assessment with the Conference Board’s take on the labor market – “Consumers’ assessment of the labor market was less favorable than last month. Those saying jobs are "plentiful" decreased to 3.9 percent from 4.3 percent, while those stating jobs are "hard to get" edged up to 46.8 percent from 46.3 percent.”

Given the fairly upbeat Christmas shopping season and continued gains in retail sales, for now the University of Michigan’s Index seems to be doing a better job of capturing the mood.

New home sales rise but overall level suggests recovery not at hand

New home sales rose 5.5% in November to a seasonally adjusted rate of 290,000 but remain 21.2% below that rate of 368,000 in November 2009.

The supply of homes for sales, based on current sales, fell from 8.8 months to 8.2 months, which represents 197,000 houses, the lowest in over 40 years.



Builders have done a good job limiting supply, as evidenced by the chart below; however, despite the recent increase in sales, the market continues to drag along the bottom and has been unable to reach the low levels established while the tax credit was in place.

Constraints include a lack of consumer confidence in the housing market that has been brought about by weak prices and the heavy supply of late-model foreclosures.  High unemployment and worries about layoffs continue to be a problem.

And tight credit standards are also hampering sales.



Until some of these issues are resolved, builders are likely to face an uphill climb enticing potential buyers.

Jobless claims holding in narrow range

Weekly initial jobless claims fell 3,000 in the latest week to 420,000, while the 4-week moving average increased 2,500 to 426000.  Continuing claims fell 103,000 to 4.06 million.



After finally leaving the range of roughly 450,000 – 500,000 that weekly claims had settled into for over a year, jobless claims appear to be settling into a new range of just above 400,000.

That does suggest that the labor market has improved a bit, as firings decrease.  It also confirms the modest pick up in economic activity that has occurred in the final months of 2010.  However, claims remain elevated amid the uncertainty that still exists.

Existing home sales rise but market still struggles

Sales of previously-owned homes continue to recover in the wake of the final expiration of the tax credits, rising for the third month in four.  But the 5.6% increase to a seasonally adjusted annual rate of 4.68 million units in November suggests the market continues to struggle.

As evidenced by the chart below, the dark bars represent the final month the tax credits were in place: the final day of November 2009 marks the last day to close on a home and still qualify for the first-time homebuyers tax credit and the final day of April 2010 marked the the last day to have a contract on a home. Hence, June 2010 might be a more accurate comparison.



In both cases, sales slipped, though the impact the second time around was more dramatic.

Sales have rebounded following the sharp drop in sales that followed the end of the credits but remain very near levels reached in early 2009.

Low interest rates and reasonable prices are providing some support, but factors such as tight credit, still-high unemployment and uncertainty over prices remain obstacles to a more robust recovery.

Leading Index points to further gains

The Conference Board’s Leading Economic Index rose an impressive 1.1% in November, generally matching analysts estimates, as the index designed to forecast future trends gained ground for the fifth straight month.

Ataman Ozyildirim, economist at The Conference Board, said, “November’s sharp increase in the LEI, the fifth consecutive gain, is an early sign that the expansion is gaining momentum and spreading.

"Nearly all components rose in November. Continuing strength in financial indicators is now joined by gains in manufacturing and consumer expectations, but housing remains weak.”



Ken Goldstein, also an economist at The Conference Board, added, “The U.S. economy is showing some sparks of life in late 2010. Overall, the indicators point to a mild pickup after a slow winter. Looking further out, possible clouds on the medium term horizon include weaknesses in housing and employment.”

The latest rise is a hopeful sign that the burgeoning economic recovery might be broadening and gaining momentum heading into early 2011.  With the uncertainty about the tax situation out of the way and a two percentage point cut in the social security taxes assured, the outlook is set to improve even further.

However, a bit of caution is in order.

The LEI did an excellent job of turning up just a few months before the recession ended, signaling the impeding recovery but the strong rise in the LEI has not been matched by activity in the real economy (see chart).

Likely reason: the interest rate spread and stock prices, which make up two of the ten components, have performed in a way that suggests a solid economic recovery would be on the horizon.

But these historical indicators of future activity, which normally might provide a sneak peek going forward, are more intangible indicators of what might be coming down the road.

Rising money supply may have also contributed to big rise in the LEI.

In the meantime, the Coincident Economic Index (CEI), which measures current economic activity, has done a good job of capturing the fragile economic recovery that has been in place for over a year. The CEI rose 0.1% last month, following a 0.2% increase in October and a 0.1% decline in September.

Housing starts gradually improve

Home builders have struggled in the wake of the expiration of the tax credits at the end of April, and builder confidence has been an accurate reflection of what's been going on in the market.

Activity continues to lag, but the latest data on housing starts and building permits may provide a reason for some very tentative optimism.
Housing starts in November did rise by 3.9% to a seasonally adjusted annual rate of 555,000, while single family starts were up a more impressive 6.9% to 465,000.  Building permits, which provide a peek at the future, slipped 4.0% to 430,000; however, single-family permits gained 3.0% to 416,000.



Looking at the chart above, single family starts and permits remain well below the levels associated with the tax credits, but we are seeing signs of a very gradual turnaround - at best.  More likely, the market is limping along the bottom.

Blame the high level of foreclosures and short sales, coupled with the weak job market. Concerns that prices could keep falling are also playing a role.

Still, getting the economy to create a significant number of new jobs would go a long way in helping the market to heal.  But for now that request is probably a bit unreasonable.

Downward trend in weekly jobless claims holds

There was little excitement from today’s report on weekly initial jobless claims as the Labor Department reported that claims fell by just 3,000 in the latest week to 420,000.  The 4-week moving average continued to show modest progress, falling 5,250 to 422,750.  Continuing claims dipped by 183,602 to 4.03 million.

Not much progress in the latest week, but the data are showing that claims are establishing a new and lower level, suggesting the labor market is slowly on the mend and economic activity is accelerating modestly.

But progress on the job front has been slow.  The recent dip does suggest we may see an improvement in December payroll number, though November’s disappointing increase in employment, if followed up by another weak number, might just be signaling that firings are down but company’s remain cautious about hiring.

Consumer inflation remains muted

The Consumer Price Index increased 0.1% in November and is up 1.1% versus one year ago.  Core inflation, which strips away food and energy, was also up 0.1%, the first increase since July. Core inflation is up 0.8% compared to one year ago, versus 0.6% in October.

That may eventually mark the low point in this cycle given that the economy is moving forward and commodity prices are rising.  But short term, inflation is not the problem.



There are a number of factors that are depressing the rate of inflation and counteracting any forces that might boost prices.

Job growth is slow and the large pool of available labor is helping to depress wage increases.  And any increases that are occurring are being absorbed by businesses through productivity gains.

Plus, aggregate demand is still sluggish and the excess capacity that remains both make it difficult for most businesses to institute all but the smallest increases in prices.  Put another way the very low rate of inflation is a by-product of a weak recovery and a nasty recession.

In the meantime, commodities, including energy, are rising; however, the largest cost for most firms is labor.  Moreover, the latest round of bond purchases by the Fed, which could threaten the price stability we are now enjoying, won’t show up in the price level in the near term.

Longer term it could become an issue if the Fed is unable to appropriately time an exit strategy.

Home builder confidence unchanged in December

The economic landscaped has improved over the last couple of months, but sentiment among home builders continues to hold at a low level.

The NAHB/Wells Fargo Housing Market Index held steady at 16 in December, indicating the builders are still pessimistic about the new housing market.  A reading of 50 suggests that builders are neither pessimistic nor optimistic.  Traffic among prospective buyers slipped a point to 11.

"Builders are bracing themselves for a slow holiday season as a number of factors continue to cause uncertainty among consumers and builders alike," said NAHB Chairman Bob Jones.

"While the HMI is adjusted for seasonal factors, the typical cold-weather slowdown in sales activity is being accentuated by ongoing weakness in the job market, the rising number of foreclosures and short-sales, and very challenging credit conditions for both builders and buyers."



At 16, the index remains well off the lows established in early 2009, but the heavy number of foreclosures and short sales, which compete for a buyer’s attention, continues to depress overall sentiment.

As the chart below indicates, confidence is a good reflection of single-family housing starts, and based on the latest figures, there are few signs that a near-term recovery is on the horizon.



Absorption of foreclosures and a significant number of new jobs would go a long way in assisting builders and boosting the industry.

Rising retail sales signal a brighter recovery

Rising consumer confidence continues to translate into an improvement in consumer spending, according to the latest data released this morning by the Commerce Department.

Retail sales in November jumped a better-than-expected 0.8%, which comes on top of an upward revision to the month of October.  Sales ex-autos improved a more robust 1.2%, suggesting that the economic recovery continues to gain traction, despite the weak payroll number last month.

Excluding an outsized 5.6% rise in gasoline station sales, which filters out rising prices at the pump, and a 0.8% dip in auto sales, so-called core sales were up an impressive 0.8%, signaling a fast start to the 2010 Christmas shopping season.



The strong rise last month may have been influenced by large promotions being offered at an ever-earlier date by retailers hoping to entice bargain-conscious consumers into their stores. And we’ll get a better picture when December’s figures come out next month.

Still, year-over-year core sales (see chart above) are not only increasing, they are rising at an ever-quickening rate, indicating that consumers are awakening from their recession-induced slumber amid the rise in consumer confidence and pick up in economic activity.

In addtion, core sales are now firmly above the peak reached as the economy entered the recession (see chart below).



Looking ahead, the extension of all of the Bush-era tax cuts for another two years and a continuation of emergency unemployment benefits will take some of the uncertainty out of the economic equation.

In addition, a partial social security payroll tax holiday in 2011, which is also part of the bill that seems destined to become law, should provide even more fuel for the recovery early next year.

Fed - steady as she goes

The Fed acknowledged in its opening statement that the economic recovery "has been insufficient to bring down unemployment." That's to be expected given the uptick in the unemployment rate in November.  But other than that, there were few changes.

Much of what the Fed said was a re-cap of the recent statement: inflation is low, household spending is rising but high unemployment, slow income growth and tight credit are restraining growth.

As expected, the Committee said it will "maintain its existing policy of reinvesting principal payments from its securities holdings....and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month."

Interestingly, however, the Fed said it "decided today" to continue expanding its holdings of securities as announced in November. Just a few short weeks after making its momentous but well-telegraphed decision, policymakers already appear to be considering adjustments.

There had been some suggestions that a third round of QE might eventually be proposed. But the tax and spending deal agreed to by Congressional Republicans and the White House was quite a bit larger in terms of stimulus than many had expected - think the partial social security payroll tax holiday during 2011.

Though costly in terms of lost revenues, the extra dollars that will end up in paychecks should give the economy a boost next year.  That makes "QE3" a lot less likely.

Improving economy lifts consumer sentiment

Preliminary data from the University of Michigan’s survey of consumer sentiment showed that consumers are moving past the summer lull in economic activity and growing a bit more optimistic about the future, despite November's rise in the unemployment rate.

The Consumer Sentiment Index increased from 71.6 in November to a mid-December reading of 74.2, the second-monthly increase and the highest reading since June.



The improvement in sentiment comes just in time for the Christmas shopping season.

Many analysts, including myself, are cautiously optimistic that the improving economy and increasing level of consumer confidence may bring some much-needed holiday cheer to recession-weary retailers.

Jump in farm products distorts wholesale inventories

A 26% rise in farm products, as well as big increases in petroleum and chemical inventories, led a huge 2.2% rise in wholesale inventories in October.  Similar increases in farm and petroleum sales resulted in a strong 1.9% rise in overall sales.  But the jump was most likely due to rising prices, which raised the value both inventories and sales.

Still, durables on hand increased a modest 0.5%, while sales grew a stronger 0.9%, indicating that production and demand remain on an upward path.

Meanwhile, the inventories-to-sales ratio held at a lean 1.18, which means that at the current sales pace it would take 1.18 months to liquidate all stockpiles.

With demand rising, we will probably see further increases in production, which should help to support the economic recovery through the end of the year and into 2011.

Colder weather eats into natural gas inventories

Natural gas inventories follow a predictable pattern during the year, rising during the late spring through the early fall as producers inject gas into storage before the onset of winter.

During the latest week, natural gas inventories fell 89 billion cubic feet (bcf) to 3,725, according to the Energy Information Administration. That puts stockpiles at 57 bcf less than last year at this time and 332 bcf above the 5-year average of 3,393 bcf.

As the chart by the EIA reveals, supplies are more than ample heading into the winter heating season, which has kept prices relatively low.

Last year’s colder-than-normal winter did help to absorb some of the excess supply but fears that a surge in natural gas production would result in new surpluses of gas helped to prevent a big spike in prices.

Similar concerns will probably restraint any outsized rise in price if temperatures in much of the country remain well below normal.

Weekly jobless claims fall

Weekly initial jobless claims resumed its downward march, declining 17,000 to 421,000, while the 4-week moving average slid 4,000 to 427,500.

Continuing claims continue to improve, falling 191,000 to 4.1 million.

The downward trend that resumed in August is signaling that the economy is firming and is also pointing to an eventual pick up in hiring.

November’s disappointing 39,000 increase in nonfarm payrolls was obviously a letdown, but a slow improvement in the labor market should eventually be reflected given the recent path we’ve seen in jobless claims.

Unemployment – the long hard road to an employment recovery

The unemployment rate is back near 10% and the economy barely created any jobs in November, highlighting the problem the economy faces in generating meaningful gains in employment.

So it comes as no surprise that the Fed has embarked on a new but controversial round of quantitative easing, while politicians in Washington continue to focus on ways to speed up the recovery.

Let’s take a moment then to graphically demonstrate how tough it has been for job seekers and the many who fear that a job loss may come their way.



The chart above looks at employment trends during the latest recession as well as the harsh recessions the economy entered during the mid 1970s and the early 1980s.   The unemployment rate soared in all three recessions, but job losses during the current slump have been about double on a percentage basis.

It also confirms that the uneven economic recovery, beginning in month 19, has failed to make a meaningful dent in the unemployment rate. In fact, the economy has yet to get us back to where we stood when the recession ended (clearly viewable in last chart), let alone coming even close to surpassing the peak level of employment reached when the economy entered the recession.

Jobs following recession’s end
The charts below provides a different angle and focuses on what happened after the recession was officially declared to have ended.

Recapping what was said above, the blue and red lines, which look at the 1974-75 and 1981-82 recessions, reflect a robust recovery in employment that was generated by strong economic rebounds.

But the last three recessions underscore how cautious firms have been in adding staff – blame more modest recoveries (see CHART).



The final chart focuses only on the recoveries from the 1991, 2001 and 2008-09 recessions, providing details that weren't available in the second graph.

Despite the trouble many are facing today trying to find meaningful employment, the recession that marked the start of the last decade, at least on a percentage basis, did the worst job when it came to generating new employment opportunities.  That happened following the extremely mild 2001 recession.



Still, the unemployment rate peaked at under 6.5% during that recession, offsetting some of the sting from that jobless recovery.

Fed policy is not a threat to price stability – at least short term

There are plenty of reasons to be worried that inflation might become a problem down the road, including the Fed’s seemingly unlimited appetite for creating money and buying U.S. Treasuries.

But with the economy slowly emerging from the worst recession in 70 years, still high unemployment and very modest wage gains remain powerful forces that are preventing businesses from enacting all but small price increases at the present time.

Yesterday’s release of the labor report, which also includes a look at wages, provides us with a good opportunity  to evaluate one anti-inflationary force that is still entrenched.

Average hourly earnings barely increased in November, and year-over-year, rose 1.6%versus a 1.7% rise in the prior three months (see chart 1).



As reflected by the chart above, the general downward trend remains intact, but it has eased over the past year.

This simply means that the high rate of unemployment and the very abundant pool of labor allow businesses the luxury of keeping wage increases to a minimum. And many are feeling queasy when it comes to demanding larger raises given the lingering job insecurities that remain.

Consequently, the largest expense for most firms is relatively stable, alleviating the need to boost prices in order to maintain profit margins.

Of course, there are exceptions.

Firms that manufacture goods are feeling the sting from rising commodity prices and are being forced to pass along some of the higher costs.

However, there is plenty of capacity still available and relatively sluggish demand makes it difficult for many to fully pass along higher raw material prices to customers.

If economic growth were to markedly accelerate, and that seems unlikely in the near term, the Fed’s pump priming machine has the potential to ignite broad price hikes throughout the economy.

ISM provides a different look at the employment picture

Today’s report by the government that nonfarm payrolls grew by just 39,000 is a stark reminder that companies are not creating nearly the number of jobs that are needed to bring down the unemployment rate.

The government’s reports is subject to revisions, and we may see upward adjustments in January and February. In addition, the general trend over the past few months is favorable, but it seems unlikely that any changes will diverge significantly from today’s release.

However, if we look at the employment indexes that are a part of each month’s release of the Manufacturing and Non-Manufacturing Indexes put out by the Institute for Supply Management, the employment picture is not quite as bad as the government report depicts.



With a reading of 50 suggesting that firms are neither adding or detracting from overall employment, the series shows encouraging growth in the all-important service sector, which increased 1.8 points to 52.7, the highest reading in over three years.  And manufacturers continue to show interest in adding staff.

The recovery has picked up steam recently, as evidenced by the upward revision to Q3 GDP, the holiday shopping season is off to a good start and Wednesday’s release from ADP regarding private sector employment was encouraging.

Like the recovery from the 2001 recession, job growth is also likely to be uneven, meaning that it may be too much to expect a consistent upward trend in nonfarm payrolls. 

Though obstacles remain, it may be only a matter of time before nonfarm payrolls more consistently reflect the firmer tone in economic activity.

ISM services signal faster growth

Despite a very disappointing employment report out this morning, the ISM Non-Manufacturing Index, which looks at activity in the broad-based service sector, increased for the third-consecutive month, rising from 54.3 in October to 55.0 in November, the best reading in six months.  A level of 50 suggests activity is neither expanding nor contracting.

Additionally, despite the weak gain in payrolls, the employment subcomponent, rose 1.8 points to 52.7, the highest reading since October 2007.



Much of the data has been suggesting that economic activity is accelerating following a lull over the summer, and the latest look at the service sector, which accounts for most economic activity, indicates the positive trend remains intact.

As the chart below reveals, employment and economic activity are closely correlated.



Growth in employment will eventually come about, but the lag has been frustrating.

Disappointing nonfarm payrolls, unemployment rate

The government reported that nonfarm payrolls rose a weak 39,000 in November, far short of forecasts, while the unemployment rate rose from 9.6%, where it had been for three straight months, to 9.8%.

The increase is all the more disappointing given the relatively favorable economic data that has been coming out – please see a more formal look on Examiner.



It’s tough to explain away the lackluster numbers, though some of the sting was softened by an upward revision to September and October of almost 40,000.  And the general trend over the past few months is favorable.

It would be nice to say that the 0.2 percentage point rise in the unemployment rate was attributed to discouraged workers re-entering the labor market, encouraged by improving economic data.

But most of the rise in the unemployment rate occurred amid job losses in the more volatile household survey, which provides the data for the unemployment rate.

Action from Capitol Hill on the way?

If there is a silver lining, weak job growth should encourage stubborn lawmakers who have refused to sign on to at least a temporary extension of the Bush-era tax cuts for all taxpayers to acquiesce.

And it may also bring about an extension in unemployment benefits, which though controversial, do provide spendable dollars to those who are most likely to use the funds for every day needs.

Since much of the recent economic data has been positive, gains in the labor market should eventually be forthcoming.

Rising Treasury yields lifts mortgage rates off the bottom

After the 30-year fixed mortgage rate hit an historical low of 4.17% three weeks ago, rates have been edging higher, rising by 6 basis points to 4.46% in the week ended December 2, according the the latest survey by Freddie Mac.

The culprit: the rise in the yield of the ten year-Treasury bond.



Mortgage rates have been in a consistent downward trend for much of the year thanks to the summer slowdown in the economy and the near absence of inflation expectations for much of the summer.

Talk the Fed would eventually embark on a new round of quantitative easing also had a temporary impact, pushing down Treasury yields.  But rising inflation expectations, also the result of the new bond buys, coupled with profit-taking in the bond market and renewed strength in the economy, has pushed yields on government bonds higher.

Mortgage rates, which track the 10-year yield closely, have reacted accordingly, rising off the bottom.

Impact on housing should be negligible. Any favorable tailwind from the drop in the 30-year rate to just above 4% (and below 4% for the 15-year fixed mortgage) has been offset by a myriad of worries that have kept many potential buyers on the sidelines.

Besides, mortgage rates are still very attractive.

Jump in pending home sales suggests market is emerging from tax credit hangover

Some much-needed goods new on the housing front – the Pending Homes Sales Index increased 10.4% to 89.3 based on contracts signed for existing homes in October.

The index remains 20.5% below a surge to a cyclical peak of 112.4 in October 2009, which had been impacted just prior to the first expiration in November 2009 of the first-time homebuyers tax credit.  We have to go back to May 2006 when the index hit 112.6 to reach the previous high.



NAR chief economist Lawrence Yun cited “excellent affordability” for October’s improvement.

But he added that “activity needs to improve further to reach healthy, sustainable levels. The housing market clearly is in a recovery phase and will be uneven at times, but the improving job market and consequential boost to household formation will help the recovery process going into 2011.”

His comment that housing is “clearly in a recovery phase” may be a bit optimistic in my view, but as the chart above reveals, the new and existing buyers tax credits that encouraged the spike in sales earlier in the year, which was then followed by a near collapse in activity (because the incentive caused many to move up plans), seems to have worked its way through the pipeline.

Activity is now being influenced – for better or for worse – by a number of factors related to the economy and the housing market, rather than being distorted by the temporary outside influence of tax incentives.

Housing prices have come down, foreclosures are encouraging some to take advantage of bargains and mortgage rates were at record lows last month when the contracts for existing homes were signed.

However, the unemployment rate remains well above 9%, the slow recovery has cast doubt over the labor market and the still-high number of foreclosures is keeping others on the sidelines  amid concerns that prices have not reached their lows.

Nonetheless, the variables that are lending support to the market do suggest sales have finally bottomed and a slow and uneven recovery appears to be in progress.

Weekly jobless claims give up advantage from prior week

Weekly initial jobless claims, which hit its lowest level in over two years last week, rebounded by a larger-than-expected 26,000 in the latest week to 436,000.  Though disappointing, the data may have been skewed somewhat by the Thanksgiving holiday, which sometimes makes it difficult to accurately account for the nuances of the holiday.

Still, the 4-week moving average maintained its downward trend, dipping 5,750 to 431,000, while continuing claims rose 53,000 to 4.3 million.



Weekly jobless claims provide an excellent look at economic activity because of the data's timeliness and because it’s an excellent measure of business confidence.

Claims have finally broken through the bottom of the range they have been in for over a year, as the declining number of layoffs is signaling a modest quickening in the pace of economic activity.

Still, numbers consistently below 400,000 would go a long way in reflecting a recovery that is finally shifting to a more permanent phase.

Debt commission takes aim at country’s fiscal woes

The bi-partisan debt commission appointed by President Barack Obama officially unveiled its plan to tackled the nation’s fiscal woes and return some form of sanity to the federal budget.

Tasked with coming up with recommendations to bring the deficit under control, the commission spared virtually no one in an effort to lop off nearly $4 trillion from the budget deficit by 2020.

And its across-the-board approach, which will cause consternation in many quarters, may be its greatest strength because compromise must involve some give and take.


The Extended-Baseline Scenario generally assumes continuation of current law. The Alternative Fiscal Scenario incorporates several changes to current law considered likely to happen, including the renewal of the 2001/2003 tax cuts on income below $250,000 per year, continued Alternative Minimum Tax (AMT) patches, the continuation of the estate tax at 2009 levels, and continued Medicare “Doc Fixes.” The Alternative Fiscal Scenario also assumes discretionary spending grows with Gross Domestic Product (GDP) rather than to inflation over the next decade, that revenue does not increase as a percent of GDP after 2020, and that certain cost-reducing measures in the health reform legislation are unsuccessful in slowing cost growth after 2020.

The chart above provides a stark look at the looming fiscal disaster that awaits if nothing is done, assuming of course (see green line) that foreigners won't willingly buy an ever-growing supply of U.S debt that currently yields less than 3% (or near zero if one buys T-bills that mature in less than 90 days).

The commission’s proposal, which at first glance seems difficult to swallow, actually encompasses modest changes in entitlement and discretionary spending that most Americans should be able to adjust to. On a side note, the changes are much less onerous than the nasty recession that we have all been forced, to some degree, to deal with.

Just the facts
An overview of the plan:
• Achieve nearly $4 trillion in deficit reduction through 2020, more than any effort in the nation’s history.
• Reduce the deficit to 2.3% of GDP by 2015 (2.4% excluding Social Security reform), exceeding President’s goal of primary balance (about 3% of GDP).2
• Sharply reduce tax rates, abolish the AMT, and cut backdoor spending in the tax code.
• Cap revenue at 21% of GDP and get spending below 22% and eventually to 21%.
• Ensure lasting Social Security solvency, prevent the projected 22% cuts to come in 2037, reduce elderly poverty, and distribute the burden fairly.
• Stabilize debt by 2014 and reduce debt to 60% of GDP by 2023 and 40% by 2035.


Note: Plausible baseline resembles CBO’s Alternative Fiscal Scenario, assuming the continuation of the 2001/2003 tax cuts protected by Statutory PAYGO, estate tax and AMT policies at 2009 levels, and a Medicare physicians' pay freeze. The baseline also assumes discretionary spending as requested in the President’s Budget and a gradual phase down of the conflicts in Iraq and Afghanistan.
2 Note that increases in this deficit level as compared to the Co-Chairs’ November 10, 2010, draft do not reflect major policy changes, but rather baseline changes to more honestly (and conservatively) account for the costs of the conflicts in Iraq and Afghanistan

Digging down into some of the components of the plan, the full retirement age for social security, which is already scheduled to rise to 67 in nearly 20 years, would rise to 68 by about 2050 and 69 by about 2075. The earliest one could receive benefits would increase lock step to 63 and 64, respectively.

Cost of living adjustments would be modified slightly, taxes on eligible income would increase gradually and the system would  become more progressive.

Discretionary spending also comes under the microscope.

If the plan passes, discretionary spending in 2012 would be equal to or lower than spending in 2011, and would then return spending to pre-crisis 2008 levels in real terms in 2013. Future spending growth would be limited to half the projected inflation rate through 2020.

The federal workforce, which has been exempt from the havoc caused by the recession, would drop by 10%, or 200,000, by 2020 primarily through attrition.

Medicare spending, which threatens to explode over the next 20 years, would also be impacted.

Don’t tax me, tax the fellow behind the tree
Those hoping the commission would focus entirely on spending are in for a disappointment but compromise dictates that taxes be a part of the equation.

In return for a simpler tax code that reduces tax brackets to as low as 8%, 14% and 23%, the cap of mortgage interest would be modified, deductions for charitable giving would change and gasoline taxes would rise by 15 cents per gallon – dedicated to transportation projects rather than the current practice of relying on deficit spending.

Additionally, the dreaded alternative minimum tax would finally die the death it so desperately deserves.

But can it pass?
The atmosphere on Capitol Hill is nothing short of poisonous.

The plan has been called “unacceptable” by at least one politician, while others view it as a starting point. Translation: how can its most '”onerous” provisions be eliminated while still passing something that shows Congress can get by with the minimum.

Of course, the recovery might just accelerate dramatically, reducing outlays while bringing in unexpected tax revenues.

But for a more likely scenario, one only has to look as far as Europe.  Greece barely avoided a financial meltdown thanks to an E.U. bailout, and Ireland quickly followed.  And now there are whispers that Portugal and Spain are next.

If the U.S. ever faces a crisis of confidence in its ability to rollover and expand its debt, the reaction in financial markets will be swift and violent, with the dollar and the stock market likely entering a free-fall. Interest rates would soar.

Spending and tax changes needed to deal with such a crisis would be draconian and unacceptable to most, as the only other alternative, monetizing the debt by the Fed, would quickly create hyperinflation.

The current plan is a bi-partisan solution that gives everyone something to cheer about and everyone something to gnash their teeth. But it provides lawmakers the cover to put this mess behind us and show the world the U.S. can and will get its fiscal house in order.

If passed, and that’s extremely questionable, it would provide a huge boost in confidence to foreign and U.S. investors alike and likely remove any chatter about whether the U.S. can sustain its triple-A credit rating.

It would also lay the groundwork for future growth that provides meaningful employment and the accumulation of wealth for this generation and generations to come.

ISM Manufacturing survey reveals steady growth

ADP has best employment reading in three years

The ISM Manufacturing Index, which is a national measure of manufacturing, fell from 56.9 in October to 56.6 in November and remained above 50, which marks the line between expansion and contraction, for the 19th consecutive month.



"The manufacturing sector grew during November, with both new orders and production continuing to expand. With the PMI at 56.6 percent, November's rate of growth is the second fastest in the last six months. Exports and imports continue to support expansion in the sector,” the chair of the Institute for Supply Management said.

He added, “Prices moderated slightly during the month, but comments from the respondents express concerns with regard to pricing pressures.”

Manufacturing has been the bright spot in what has otherwise been an uneven and dull economic recovery so far.

However, recent indications suggest that the uneven recovery is beginning to broaden.

ADP report reveals favorable job trend
ADP announced this morning that private-sector employment increased by 93,000 in November, noting that the report suggests and acceleration in job creation and that “the nation’s employment situation is brightening somewhat.”

October’s originally reported gain of 43,000 was revised upward to 82,000, adding to the positive flavor of the release.

The best increase in three years, however, is not enough to bring down the unemployment rate, as ADP was quick to point out that the unemployment rate will likely hold above 9% for all of 2011.

Still, the report, which front runs the government’s labor report by two days, has lagged well behind the nonfarm payroll number for the entire year, and November’s relatively upbeat number is suggesting that Friday’s labor report might pleasantly surprise to the upside. 

At a minimum, last month’s rise is signaling that the recovery is beginning to pick up steam, as companies begin to fill vacancies needed to take advantage of improving markets.

Excess reserves and quantitative easing

Why the Fed's latest plan won't have much impact

The Federal Reserve, in what had to be the most anticipated shift in monetary policy history, announced four weeks ago that it plans to buy an additional $600 billion in longer-term Treasury bonds.

Known as quantitative easing (QE) , which is defined as purchases of securities over and above what is needed to keep short term rates at zero, the new bond buys are part of the Fed’s own stimulus program that is designed, at least in theory, to boost the economy, create new jobs and prevent deflation from taking hold in the U.S. (was always just a very remote possibility in my view).



The first round of QE – about $1.8 trillion in bond buys – did help to stabilize the financial system in late 2008 and early 2009 when the implosion in credit markets threaten to send the U.S. and global economy into a worldwide depression.

The Fed did help to stave off a crippling depression, but failed to prevent the worst economic contraction in over 70 years, highlighting the limits of monetary policy.

Aversion to risk – the roadblock to recovery
Risking taking all but disappeared two years ago, as banks and just about everyone else sought safety and capital preservation. Hence, as the chart above reveals, excess reserves – defined as cash that is over and above what’s required to be held in the event of emergency customer needs – exploded.

And this aversion to risk among banks and consumers, which has played a major role in hampering the recovery, becomes clear when one sees that banks are holding nearly $1 trillion in excess reserves!

This time around, as the Fed gets set to prime the pump once again, things are a bit different.

Though the world’s largest economy and much of the developed world continue to slowly emerge from the recession, China and other emerging markets (EM) are experiencing robust growth.

With the Fed set to pump $600 billion in newly minted cash into the system - QE2 as it is commonly called, much of the new stimulus seems likely to find its way into the faster-growing economies, further propelling EM growth and risking new asset bubbles around the world.

Additionally, speculation in investments that have performed well in the last year may also be the beneficiary of this newly created cash. Think gold, oil, copper and a host of other raw materials.  That in turn is already stoking inflation in commodities.

Consequently, with the huge piles of cash still sitting on the sidelines, it seems very unlikely that new bond buys will have much of a direct and favorable impact on the U.S. economy.

Unless policymakers at the central bank are able to employ an exit strategy at just the right time, inflation could easily extend beyond commodities.

Consumer confidence hits highest level in five months

The Conference Board’s Consumer Confidence Index hit its highest level since June, rising 4.2 points in November to 54.1.

The improvement is welcome news to retailers heading into the holiday shopping season, suggesting that consumers won’t be so conservative when the search the malls for that perfect gift.

Many retailers are still offering up excellent bargains in order to attract recession-scarred shoppers, but the second-monthly increase in consumer confidence is signaling that some may go beyond sale items, which should help fatten profit margins.



Consumer confidence remains at a relatively low level and is still stuck in the narrow range it has been in for over a year.  That's not surprising given the summer slowdown and an unemployment rate that remains stubbornly above 9%.

However, the job market is slowly starting to improve, while weekly jobless claims fell to the lowest level since June 2008 last week.  Moreover, the Conference Board’s survey revealed that most consumers are feeling a little better about what’s happening to the labor market, which is aiding sentiment and appears set to support economic growth.

Falling new home sales contrasted by good news on jobless claims

New home sales plummeted a much larger-than-expected 8.1% in October to an annual rate of 283,000 units.  That bolstered the supply of homes from 7.9 months to 8.6 months.

However, the 8.6 months is based on the paltry number of sales.  With the actual supply just above 200,000, the number of homes on the market stands at the lowest reading since the late 1960s.

Still, the big drop in sales reflects the stiff headwinds the housing market continues to face in the wake of the expiration of the tax credits last spring.

Potential buyers are worried about the potential for further declines in prices, and the lack of any meaningful job creation is holding others back, offsetting record low mortgage rates.

In the meantime, weekly jobless claims tumbled  34,000 to 407,000 in the latest week, indicating that economic activity is accelerating and the job market is set to pick up.

Next week's data may be blurred by the Thanksgiving holiday, but the downward trend is definitely welcome news.

Philly Fed Index continues string of data showing improvement

The Philly Fed Index, which takes a look at manufacturing conditions in the mid-Atlantic region, is showing a noticeable improvement in economic activity, as the survey released by the Philadelphia Federal Reserve jumped from 1.0 in October to 22.5 in November, the best reading in a year.


(Source: Philadelphia Federal Reserve)

New orders moved back into positive territory, rising from –5.0 to 10.4, suggesting further gains in production, while shipments jumped for 1.5 points to 16.8.

The acceleration in activity also had favorable impact on hiring, which increased from 2.4 to 13.3.

However, rising demand around the globe, especially in China and other emerging markets, coupled with the re-introduction of quantitative easing by the Fed, is keeping upward pressure on raw material prices.

Prices paid rose 2.5 points to 34.0.  But the still-sluggish U.S. recovery is making it difficult to pass along higher commodity prices, as evidenced by a –2.1 reading on the prices received component.

Looking at the chart above, the summer soft patch has faded.  Just as important, the improvement in the Philly Fed signals that the weakness we saw in the more volatile and narrow Empire Manufacturing Index was very likely an aberration.

Expect the economy to gradually improve heading into the end of the year.

Jobless claims in process of establishing new range

Weekly initial jobless claims held below 440,000 for the third week in four, helping to confirm the recent downward trend.

Weekly claims did rise 2,000 to 439,000 in he latest week, but the 4-week moving average, which smooths out the volatility in the weekly data and is a better gauge of the market, fell 4,000 to 443,000.  Continuing claims dropped 48,000 to 4.3 million.

Jobless claims appear to be settling into a new range after hovering in a band between about 450,000 to 500,0000 for over a year.

The slight, downward trend not only suggests that that labor market may be slowly firming, but it is also an indication that economic activity is gradually picking up.  Though consumer confidence continues to languish, other data, such as retail sales, have been improving.

Nonetheless, any enthusiasm from the recent drop in jobless claims needs to be tempered by the fact that claims remain elevated and any improvement in the economy is likely to be modest.

Core CPI perilously close to zero

Fed action, recovery make deflation unlikely

The core CPI held steady for the third month in a row, and core prices slipped from 0.8% year-over-year in September to just 0.6%.

That might normally set off alarm bells at the Fed, but seasonal factors may have played a role in October’s number.



Additionally, the Fed’s latest round of quantitative easing has all but eliminated the slim chance that the U.S. will slip into deflation.

Still, at 0.6%, there is little in the way of retail inflation in the economy.

Detail available in my report at Examiner.

Tumbling multi-family starts hammer housing starts

A 47.5% drop in multi-family starts last month was responsible for a much larger-than-expected 11.7% decline in housing starts to a seasonally adjusted annual rate of 519,000.  Pull out the volatile multi-family category and housing starts were down 1.1% to 436,000 in October.

Building permits didn’t fare much better, rising 0.5% to an annual rate of 550,000, while single-family permits inched up 1% to 406,000.



Home builder confidence has been edging higher, but as the chart above reveals, single-family permits for new homes, which is a good forward-looking indicator of the industry, has been dragging along the bottom for several months.

New home sales make up less than 10% of the overall market, but residential construction feeds directly into GDP, while increased employment and the ripple effect throughout the construction industry would have a more indirect impact on GDP.

Builders must still contend with the heavy backlog of foreclosures of later model homes, and still high unemployment and depressed consumer sentiment continue to hamper the industry.

Intro of new car models pulls down core producer prices

Led by a 3.7% rise in energy prices, the Producer Price Index increased a modest 0.4% in October. The index rose 4.3% versus a year ago. 

But core prices, which remove the volatile food and energy category, tumbled 0.6% last month amid a steep drop in auto prices.  Core prices are up a modest but non-threatening 1.4% versus one year ago (see chart below).



Blame the steep drop last month on difficulties in accounting for seasonality that comes from the introduction of 2011 autos.  Looking back at October 2009, core prices also tumbled, indicating that the one month drop is very likely an aberration and not the beginning of a new trend.



Given recent strength in commodity prices that have been tied to stronger demand from overseas and QE2-fueled speculation, intermediate prices (see chart above) continue to steadily gain ground, while core goods (see chart below), which are especially sensitive to changes in demand, remain in a steady upward trend.



Demand in the U.S. economy remains sluggish, making it difficult to substantially raise prices, and wages, which are the largest expense for most businesses, are rising at a very gradual pace.  Consequently, retail inflation is likely to remain under control in the near term.

Housing Market Index shows slight improvement

The Housing Market Index, which gauges builder sentiment, increased one point to 16 in November, the second consecutive monthly gain.  A reading of 50 suggests that builders are neither confidence nor pessimistic.



"Though the gains have been incremental, the fact that builder confidence has improved over the past two months is encouraging," said NAHB Chairman Bob Jones, a home builder from Bloomfield Hills, Mich.

"Many builders are reporting that while the quantity of buyer traffic through their model homes has not improved dramatically, the quality of that traffic seems to be getting better – meaning that more people appear to be serious about buying in the near future. Builders remain very concerned, however, about the lack of available financing for new-home construction at a time when inventories of completed new homes are quite thin; after all, you can't sell what you can't build."

We are seeing incremental gains in builder confidence, though at current levels, sentiment remains very depressed.

With the exception of the artificial increase tied to the tax credits that expired at the end of April, overall builder confidence appears to have barely broken out of the downward trend that reestablished itself over a year ago.

Extraordinarily low mortgage rates may be helping at the margin, but low rates have not provided the support that the beleaguered housing market desperately needs. 

A winding down of foreclosures, which competes with new homes, rising consumer confidence, stabilization in home prices and a falling unemployment rate would go a long way in solving what ails the new home market.

Volatile Empire Index sinks into negative territory

The Empire Manufacturing Index, which is a narrow but early look at manufacturing and focuses only on New York state, fell 27 points to -11.1. The new orders index plummeted 37 points to -24.4, and the shipments index also fell below zero.


Surprisingly, given the sharp increases in many commodity prices, the prices paid index fell 8 points to 22.1, suggesting that the pace of price increases slowed in November. The prices received fell 11 points to -2.6—a sign of slight downward pressure on selling prices.

As already mentioned, this index tends to be fairly volatile, which can be seen by the chart above provided by the New York Fed.

The global economy has been improving and U.S. exports are gaining traction.  And most other U.S. economic indicators, including the six-month outlook that is part of this survey, continue to flash cautiously optimistic signs.

Unless confirmed by other data, this report is an outlier and should be ignored this month, in my opinion.

Gains in retail sales reflect improving economy

Led by a 5.0% rise in auto sales, advance retail sales increased an impressive 1.2% in October, well ahead of forecasts.  Pulling out the jump in autos, sales still managed to climb a respectable 0.4% in October, which comes on top of a small upward revision in September.

Looking at so-called core sales, which excludes the volatile auto category as well as gasoline station sales – so that the rise in gasoline prices is filtered out, sales still managed to increase 0.4%.

Despite lackluster consumer confidence, retail sales continue to slowly improve, as evidenced by both charts.   What may come as a surprise to many is the fact that sales ex-autos and core sales are actually above where they were when the recession began in December 2007. 

The inability to surpass the December 2007 level for overall sales, however, reflects the slow recovery in autos.



Still, the rise in core sales is a strong sign that the health and pace of the recovery is improving. Moreover, the rate of improvement has been accelerating (see chart above), which suggests that economic activity is also gradually picking up.



Despite the relatively favorable tone to today’s report, retailers won’t be shelving plans to offer steep discounts during the Christmas shopping season, but recent data suggest that some establishments may be pleasantly surprised, as consumers slowly re-engage during the upcoming and all-important holiday shopping season.

Eventually, and maybe sooner rather than later, a more even recovery should translate into more hiring (see Growth is the cure for high unemployment). 

Consumer sentiment stabilizes, inflation expectations rise

Preliminary results show that the University of Michigan’s consumer sentiment survey increased from 67.7 in October to 69.3 in November, just ahead of the Bloomberg estimate of 69.0. Notably, short-term inflation expectations jumped, but more about that in a moment.



Consumer sentiment, which took a beating when the already fragile and uneven recovery slowed during the summer, has stabilized and is beginning to inch higher amid a very modest acceleration in economy activity over the past couple of months.

The modest drop in weekly jobless claims is alleviating some of the anxiety about potential layoffs, while the private sector has created over 100,000 jobs per month in each of the last four months.

Still, the job creation remains below the 150,000 needed to bring down the unemployment rate, and without a noticeable pickup in the labor market, consumer confidence will likely remain depressed and hold back spending among the nation’s consumers.

Rising inflation expectations - keeping the genie in the bottle
So far just the talk in September and October that the Fed might initiate a new round of bond purchases, coupled with the green light the Fed gave in November, has reversed the drop in inflation expectations – at least over the short term.

According the the University of Michigan’s survey, consumers now anticipate that prices will rise 3.0% over the next 12 month, up from 2.7% last month and a paltry 2.2% in September.  Longer-term the 5-year outlook held steady at 2.8%.

Oil prices have jumped over the past two months, with the price approaching $90 per barrel, gold has soared above $1,400 per ounce, while the key industrial metal copper has returned to the highs reached in 2008.

It’s clear that rising demand around the world, especially in China and other emerging market economies, has supported prices.

But rising speculation created by the second round of quantitative easing that was just initiated by the Fed is producing a run up in commodity prices.  And consumers have not turned a blind eye to what’s going on, lifting their view as to what may happen to prices over the next year.

The Fed can do little to contain commodity inflation, given current monetary policy and global demand for raw materials. But it must remain vigilant in its efforts to anchor inflation expectations.

Import prices in modest upward trend

Led by a 3% rise in fuel costs, import prices increased 0.9% in October, while the price of imports less the cost of fuel rose a modest 0.3%, the third such rise in as many months.

Year-over-year, import prices are up 3.6%. Excluding fuel, prices are up a more reasonable 2.5% from a year ago.


(Source:BLS)

Delving into the data, October’s increase was skewed heavily by rising food and raw material costs as well as the increase in petroleum prices.

It comes a no surprise that higher raw material costs are impacting the Import Price Index, given that a number of commodity prices have jumped in recent weeks. 

Overseas growth, especially in China and emerging economies, are forcing prices higher, while the expectation in late summer and early fall that the Fed was ready to embark on a new round of quantitative easing – made official on November 3 - also fueled speculation in these commodities.

However, outside of oil and many commodities, prices are holding steady.

Capital goods – 23% of the index – was unchanged in October, while consumer goods – another 25% – fell 0.5%.  Year-over-year, prices are down 0.1% and 0.6%, respectively, indicating that nearly half of all imported goods, finished goods in this case, continued to be affected by the weak U.S. economy, which makes it difficult to boost prices.

If the dollar continues in its downward trend, we may eventually see small amounts of imported inflation, but much depends on how quickly demand ramps up in the U.S. economy.

Falling jobless claims signal expanding economy

Out a day early due to tomorrow’s Veteran’s Day holiday, weekly initial jobless claims fell a steep 24,000 in the latest week to 435,000, the second week in three that claims have fallen below the stagnant range they’ve been in for over year and below the Bloomberg estimate of 450,000.

The 4-week moving average dropped an impressive 10,000 to 446,000.



Continuing claims, which have been more difficult to interpret in this cycle because many are filing for emergency extensions that aren’t included in the figure, remain in a downward trend, dipping 86,000 to 4.3 million.

The 4.3 million does not include those on extended benefits. But the downward trend in the six-month standard payment does suggest that laid off workers, though still facing an uphill climb, may slowly be reaping the benefits of an improving economy.

Weekly claims remain elevated and obstacles are still in the path that might lead to a more vibrant expansion.  But activity does appear to be shifting into a higher gear, albeit slowly, and that should assist with job creation and put the economy on a firmer footing.

With the exception of a statistical quirk that caused claims to hit 428,000 in July, jobless claims are now at the lowest level in over two years and remain in the narrow downward trend that began in August when claims hit a weekly peak of 504,000.

Next week’s data may be skewed by tomorrow’s federal holiday, but the receding level of layoffs, combined with cautiously upbeat signals from most indicators, suggest employers are growing more confident.

With the election behind us and the unveiling of the Fed’s shift in monetary policy, both which are alleviating some of the uncertainty that’s been hampering growth, I am cautiously optimistic that we may finally be seeing the start of a long-awaited acceleration in economic activity.