Moody’s and Fitch frown on EU’s historic accord

Last Friday’s agreement to keep the euro zone from splintering was billed as an historic accord that would require deeper fiscal integration with the threat of sanctions if member states didn’t abide by tough budget rules.

On modest volume, stocks gained ground on Friday but credit markets were a bit more cautious.

Much like the October 27 agreement to save Greece, scrutiny and the glare of the spotlight are already giving rise to the naysayers.

Moody’s noted prior to the opening this morning, “The communiqué issued by European policymakers after the recent euro area summit offers few new measures and therefore does not change our analysis of the rising threat to the cohesion of the euro area and the further shocks to which it and the wider EU remain prone.”

Not wanting to be left out of the fun, Fitch Ratings at midday added, “The gradualist approach imposes additional economic and financial costs compared with an immediate comprehensive solution. It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond.”


Counterparty risk: Rising overnight bank deposits at the European Central Bank highlight growing fear in Europe.

Both agencies warned that downgrades remain a possibility. Stay tuned.

Stocks warm to elusive eurozone solution

Stocks finished last week in a favorable fashion amid signals from eurozone leaders that a solution, or at least some type of stop-gap measure that provides breathing room, is at hand.

The Sunday deadline was pushed back to Wednesday, but that didn’t hinder the bullish mood on the Street on Friday.

Despite the optimism that has been aided by numerous sound bites, credit markets don’t seem to be buying it. Yields on European bonds have been rising, and tension in the credit markets has yet to abate.

3-month LIBOR Rate

Source: FreeStockCharts.com

European leaders are aware of the consequences of not getting a deal done. I suspect a compromise is in the works, but will it be as far-reaching as some equity players are hoping for?

Weekly jobless claims back below 400,000

Weekly jobless claims fell 37,000 in the latest week to 391,000, the first time since early April that jobless claims dipped back below the psychologically important 400,000 level.

The unexpected decline also had a favorable impact on the 4-week moving average, which slipped 5,250 to 417,000.

Although this is one of my favorite leading indicators because of its timeliness and its read on business confidence – note, its rise above 400,000 in the spring provided an early warning signal on the impending slowdown, I’m skeptical about today’s welcome drop since there has been little else to suggest that a much-needed pick up in economic activity is at hand.

Further, Bloomberg News reported that difficulties in making seasonal adjustments may have played a role.

I’d like to wait for another round or two of data.

Fed begins two-day meeting against weak backdrop

The Fed began its two-day meeting today and will conclude tomorrow against the backdrop of a floundering economic recovery and a jobless rate north of 9%.

Most analyst believe the Fed, which pledged to hold rates low until at least mid-2013 at the August meeting, will take another step toward easing in the hopes of jump-starting employment growth.

Promising to hold rates low for another two years appears to have done very little for the economy and many believe new steps will have just a limited impact.

The Street expects the Fed to extend the length of its bond portfolio, popularly called “Operation Twist,” by swapping shorter-term debt for longer-term debt.

Theoretically that might lower longer-term rates.

But how much this is already priced into the yield curve is unknown, and long-rates are already at historic lows – a 4% 30-year fixed rate mortgage. And potential home buyers aren’t jumping at the bait.

So it stands to reason that even lower rates would have just a muted impact on the economy.

Despite expectations, correctly calling what the Fed may do can be as dicey as calling the offensive play on third and goal at the five.

Will it be a run up the middle, sweep around the end, QB rollout and pass? Maybe it’s not that tricky but it’s possible the Fed could surprise.

A full-blown QE3 – always a possibility – could be implemented, but the track record for QE2 – higher inflation and anemic growth – suggests we’d get even less bang for the buck this time around.

The Fed could cut the rate it currently pays on excess reserves (near $1.6 trillion) from 25 basis points, as it hope to encourage lending.

However, lending institutions are already forgoing higher rates on credit cards, mortgages, auto loans and business loans by earning just a paltry 25 bp!

Cutting the rate by 10, 20 or the full 25 would provide little incentive to lend when many are shying away from new debt.

Further eliminating the rate on excess reserves could make it more difficult for the Fed to manage the fed funds rate.

Unfortunately for the millions who remain jobless, the Fed has few credible options left in its arsenal.

Faltering consumer confidence takes a toll on retail sales

Consumer confidence, as measured by both the Conference Board and the University of Michigan, went into a tailspin in August – thanks in large part to the divisive debt ceiling debate, the S&P downgrade, the faltering stock market and the deepening gloom emanating from Europe.

With growing uncertainty and weak job and income growth, retail sales out this morning had been highly anticipated since it would provide a concrete gauge on the public’s mood.

Unfortunately, the best consumers could muster was a flat reading in August. Excluding autos, sales managed a meager 0.1% rise.

Further, June and July were revised lower.

Last month’s free-fall in consumer confidence, along with the factors mentioned above, very likely accounted for the weak showing at the nation’s malls.

If there is a silver lining, sales did not mirror the steep drop in confidence, and it appears the economy continues to expand at a very tepid pace.

But the anxiety many of us feel is being reflected in the latest numbers offered up by the government.

Growth in nonfarm payrolls stalls

The government reported this morning that nonfarm payrolls in August were unchanged from the prior month.

That’s right – no change, zero. In the meantime, the private sector added just 17,000 jobs and the unemployment rate held steady at 9.1%, the fifth consecutive month the jobless rate has held above 9.0%.

A more formal look is available at Examiner.



Simply put, fiscal and monetary policy have their limits and we are seeing this play out before our eyes.

The president proposed and passed an$800 billion stimulus package early in his administration.

And the Fed has kept rates at zero for over two years and has pledged to keep rates low for another two years.

It has also pumped over $2 trillion into the economy in what is popularly called QE2.

The end result: very weak economic growth and a stubbornly high unemployment rate.

Pending home sales reflect sluggish housing market

The Pending Home Sales Index, a forward-looking indicator based on contract signings, slipped 1.3% to 89.7 in July from 90.9 in June.



One again, Lawrence Yun, the NAR’s chief economist, noted that tight lending standards continue to hamper the existing home market.

Based on anecdotal evidence from realtors, he is probably correct, but his assertion that “The market can easily move into a healthy expansion if mortgage underwriting standards return to normalcy” is a bit premature in my view.

Potential buyers continue to fret over the direction of home prices, and others who would like to move are finding it difficult to sell their current home or are unable to fetch a price that would leave them with the necessary equity to invest in a new house.

Further, job insecurities and lackluster consumer confidence, along with competition from foreclosures, remain a headwind.

Spending powers ahead
A welcome surprise for an economy that has been awash in weak data. Consumer spending grew by a healthy 0.8% in July.  A rebound in purchases for durable goods, including autos, led the way but gains were broad-based.

Even accounting for a rise in headline inflation, real spending, or spending adjusted for inflation, increased by a solid 0.5%, the best reading since December 2009.



But the overall trend remains lackluster, as the slowdown in income growth – compliments of weak employment growth – hinder spending.

Additionally, the debt ceiling debate that has sapped confidence may not manifest itself in the numbers until August. Stay tuned.

Bulls sniff out another round of Fed easing

Fed Chief Ben Bernanke’s talk on Friday at Jackson Hole, WY will likely be the event of the week given the recent unexpected weakness in the economy and the many debt problems that are plaguing Europe.

Clearly, this has tripped up the bulls over the last month, taking a big toll on equities and lending a helping hand to Treasuries.

But Monday and Tuesday have come as a big relief to investors, especially the strong advance yesterday.

Many traders tend to take the final week or two of August off, and a potential lack of liquidity may be accentuating the market moves.

Bargain hunting – stocks appear to be cheap if you are betting against a recession or a near-term default in Europe – is likely a contributor to the rally.

But the biggest reason, in my view, is the lack of any damaging headlines out of Europe and the expectation that Bernanke’s Fed is ready to come to the rescue with more talk of easing.

Recall that Bernanke first hinted at what would eventually be known as QE2 at last August’s meeting in Jackson Hole. That surprised markets.  And he surprised them again in early July by lowering the bar for implementing a more aggressive monetary policy.

Inflation is higher today than a year ago but this time around, the economy is unusually fragile.
Stocks have become addicted to regular Fed injections of liquidity, and another sugar high – compliments of the central bank – seems like a good short term fix.

But the last round of QE did little for the real economy since the $600 billion in new money is currently being held by banks and is on loan back to the Fed in the form of excess  reserves.

And inflation in the U.S.is higher today while emerging market economies like India and China are hiking rates in order to contain rising prices.

The Fed may try to surprise markets by calling for further unconventional action or measures that haven’t been publicly discussed, but the last round of QE was counter-productive since it exacerbated commodity inflation and contributed to higher rates overseas, which has slowed U.S. exports.

Stocks slump, economic data weak

A sell-off that began early this morning in Europe quickly spread to U.S. markets amid lingering fears over European debt and concerns that the U.S. and European economies may be poised to enter a new recession.

The flight out of equities continued to bolster Treasuries, with the 10-year bond briefly falling below 2% for the first time ever, while gold also benefited from the fall in stocks.

In the meantime, the latest economic data did little to discourage a small but growing view that the U.S. economy is either poised to enter a new recession or may already be in a new slump.

The Philly Fed’s Business Activity Index fell an astonishing 33.9 points in August to -30.7, far below the level of zero, which marks the line between contraction and expansion.

Yes, the index can be volatile but there's little good to say about August's number.


Losses in the sub-components were broad-based, suggesting the survey is detecting serious weakness in the mid-Atlantic region.

In the meantime, existing home sales unexpectedly fell last month, continuing a downward trend that re-established itself early in the year.

A lack of confidence in the economic recovery, worries about prices and job insecurities played a role.  Additionally, the NAR expressed growing frustration that conservative appraisals are scuttling some deals.

All-in-all, rather disconcerting.

Dow tumbles 635 points in wake of S&P downgrade

What an awful day on the Street.  In the wake of S&P’s downgrade of U.S. sovereign debt on late Friday, global markets, and the U.S. in particular, reacted violently to the country’s loss of its cherished AAA rating.

Never mind that the downgrade had been telegraphed in advance.

Never mind that Standard & Poor’s had been the U.S.’ harshest critic on deficit spending, stating a month ago that there was a 50-50 chance of a downgrade if a $4 trillion plan was not put in place.

Never mind, as Bloomberg News noted, that France, Germany and the U.K., which still hold the coveted rating, all have CDS costs – or insurance against default – that is higher than that of a U.S. Treasury note.

Still, the timing of the downgrade could not have come at a worse time, as heightened recession concerns and growing debt woes in Europe took a huge toll on the market last week.

Not surprisingly, gold prices jumped in reaction to the instability, but interestingly, investors also sought safety in Treasuries, despite the opinion by S&P that government debt no longer warrants the gold-standard AAA rating.

Without question, Bernanke’s Fed has been very closely watching the fluid situation in the financial markets, as well as the recent spate of weak economic data and the still-unfolding situation in Europe.

QE2, when it was all said and done, had little impact on the real economy, and the jump in stock prices we saw earlier in the year, which Fed officials were happy to trumpet, has all but evaporated.

Further, the extra cash the Fed injected into the system exacerbated commodity inflation, which has hurt the economy.

That doesn’t  mean equities, which are looking for their next fix from the Fed, would shun another infusion of central bank liquidity.

It only means that it’s a temporary solution to a bigger problem. We’ll know more on Tuesday at the conclusion of the Fed’s meeting.

Collapse in longer-term Treasury yields sends ominous signal

Stocks are falling and investors are running into the arms of Treasuries, seeking safety in the midst of economic turmoil.

Not what one might have expected last month amid fears that the growing federal budget deficit might scare away foreign buyers.



We can discern two things:

1. The U.S. Treasury market remains a safe-haven, even as the U.S. budget deficit explodes.
2. The bond market is running scared, fueled by fears that another recession is imminent.

The weak economic data, starting with the downward revision to GDP, which was then followed up by a disturbing report on manufacturing, has definitely gotten the attention of Fed officials who had been anticipating a pickup in activity later in the year.

Throw in the sudden rush into Treasury bonds and you have wonder if Bernanke and Co. are starting to panic.

Jobs data on Friday may hold the key to whether the Fed will announce new plans to boost the economy.

Inflation expectations have not plummeted along with Treasury yields, but at this juncture, you have to say the odds seem to favor some type of action.

ISM suggests manufacturing growth has stalled

Following Friday’s anemic GDP number, the ISM survey suggests that manufacturing growth pretty much stalled last month.

The ISM Manufacturing Index, offered by the Institute for Supply Management, declined from 55.3 in June to 50.9 in July, well below the consensus from most analysts of around 54.



To make things worse, new orders turned negative – 51.6 to 49.2 – for the first time since June 2009 when the recession was officially declared to have ended. That suggests further weakness in the short term.

Employment remained positive but is decelerating – 59.9 to 53.5 – and given the weakness in the manufacturing sector, prices paid continued to recede, dropping from 68.0 to 59.0.

Following the downward revisions to GDP in Q4-10, Q1-11 and the weak growth we saw last quarter,  the poor showing by a key survey of manufacturing is clearly disturbing.

This once hot sector – and one of the few bright spots in the economy – has slowed dramatically.
The earthquake in Japan and the subsequent kink in the supply chain has played a role, but other factors are also weighing on growth.

Japanese industrial production, though not fully recovered, is growing at a decent pace, and that should help U.S. manufacturing, especially auto production.

I still believe we will avoid an outright recession this year, but we are perilously close to a growth recession – one in which the economy grows but unemployment rises (that’s already happening) and nonfarm payrolls fall.

Two minutes to midnight–Aug 2 deadline upon us

All the bickering and acrimony in Washington might make for a good reality TV show, if one enjoys such drama and stress, but the consequences of failure in the debt ceiling negotiations are real and must be avoided.

Upbeat earnings seem to have been the one bright spot preventing additional losses in stocks last week. But the looming August 2 deadline and the drama on Capitol Hill have overshadowed any good news.

And virtually no one wants to navigate the uncharted waters of a debt default should the deadline be breached.

I suspect that if there is no agreement, and I still believe we’ll see one before Wednesday, the government will continue to make interest and principal payments and seniors won’t miss a social security check, but the chaos that would ensue would likely rattle markets even further.

But even with an agreement, numbers being bannered about fall far short of what S&P says is needed - $4 trillion in savings over 10 years – to avoid a downgrade.

Democrats want a plan that saves over $2 trillion and raises the debt ceiling by a like amount that would put off another vote until after the 2012 elections.  Republicans complain that about $1 trillion in savings is coming from the winding down of the wars in Iraq and Afghanistan - money that wasn't going to be spend anyway.

Republicans want to save about $1 trillion over the next ten years and vote again on the debt ceiling, before the 2012 elections.  They would also like to vote on a balanced budget amendment at that time.

It's not surprise why each side is offering their own separate plan.

Republicans would like to see Democrats squirm just prior to the election, when they'd likely vote against a balanced budget amendment. And it would remind voters that trillions of dollars in red ink have accumulated under Obama's watch.

On the other hand, Democrats would like to avoid another bitter display of partisanship next summer and kick the can to 2013.

Given the uncertainty the markets are dealing with, it seems reasonable not to manufacture another crisis a year from now.

Still, even with an agreement, it seems likely that at least one credit agency will void the county’s AAA credit rating. In theory, that translates into more risk and higher interest rates, especially if some pension funds and institutions, which can only hold AAA debt, are forced to sell.

But what will actually happen is unclear, and experts are divided since we’d be in uncharted territory.

Alarm bells at the Fed
The economy right now does not need higher interest rates. An early look at Q2 GDP that came out on Friday reflects the fragile nature of the recovery. And the unexpected downward revision to Q1 only adds to the uncertainty.

It’s becoming increasingly clear that Fed Chairman Ben Bernanke’s plan to buy $600 billion in Treasuries – popularly known as QE2 – has failed to boost output.

It helped lift stock prices and it exacerbated commodity inflation, but the extra money sloshing around the banking system has not helped the economy.

Unfortunately, weak job growth and a sharp slowdown during the first half of the year has Bernanke talking about another round of easing. But the evidence suggests that it would only fuel speculation, create additional distortions, and risk more inflation.

Weekly jobless claims back below 400k but special factors muddy data

Good news…sort of.  Weekly jobless claims are back below 400,000 for the first time since early April. But seasonal adjustments may not be capturing certain factors that led to the welcome decline.

Weekly initial jobless claims dropped 24,000 in the latest week to 398,000.

The 4-week moving average, which smooths away some of the volatility in the weekly number, dropped 8,500 to 413,750. Continuing claims were down 17,000 to 3.7 million.

Anytime we see jobless claims come in well above or below the consensus forecast – in this case, 425,000 per Bloomberg – its important to footnote the drop by noting that this number can be volatile on a week by week basis.

Moreover, retooling in the auto sector at this time of year further muddies the data, even with seasonal adjustments.

At a time when gauges of economic activity are detecting economic weakness, the dip is welcome, but let’s keep a close eye over the next couple of weeks so we can confirm whether or not a very modest pick up in economic activity is at hand.

Nervousness in stocks not seen in Treasury market

Late Wednesday July 27 addendum: Up until now, the Treasury market has been fairly calm, but over the last couple of days, we've started to see an uptick in Treasury yields mostly at the short end of the curve, suggesting nerves are starting to become a bit frayed as the deadline approaches. No big leap in yields but a minor rise in the 3-month T-bill is worth noting.

The remainder of the article is available below.

With August 2 deadline for a debt deal casting a long shadow over U.S. and global equity markets, the Treasury market, which would be immediately impacted by a default, doesn’t seem to be as rattled.

Yields on T-bills over the past month have traded between 1 – 5 basis points, which realistically means you and I can park cash short-term and more or less earn what we could if we stashed it under a mattress.

And the benchmark 10-year bond is offering a yield of just about 3%, so longer-term, a domestic or foreign investors receives something for lending the government cash, but the paltry yield suggests nothing out of the ordinary looms in the foreground.



Further, measures of risk, such as the 2-year interest rate swap spread, or the difference between the yield on the two-year note and the yield on a two year swap, has been well-behaved.



All of this suggests that bond players believe the Republicans and Democrats will pass some type of increase in the debt ceiling before Treasury misses an interest payment.

AAA going the way of the dinosaur?
Of course, credit agencies have been carefully monitoring the situation and have warned that a debt ceiling increase must be accompanied by a credible plan to reduce the federal deficit.

If a more symbolic plan to reduce deficit spending is enacted, i.e., smoke and mirrors and phony cuts, the U.S. faces the real possibility of losing its coveted AAA credit rating.

And one would have to assume that both domestic and foreign investors would demand a higher premium to buy U.S. debt.

That means higher interest rates at a time when the fragile recovery does not need another impediment to growth.

Existing home sales languish

As traders focus on a spate of upbeat earnings and politicians continue to tease the public with talk of sizable debt reduction, housing remains a headwind to a more permanent recovery.

Existing home sales eased up slightly in June, falling from an annualized pace of 4.81 million units in May to 4.77 million units in June, marking the third consecutive monthly drop in sales.

Unfortunately, the supply of houses on the market continues to edge higher, which seems likely to keep pressure on prices.

Housing affordability is at a record high, according to the National Association of Realtors, and mortgage rates have been hovering well below 5%.

But there is just too much uncertainty in the housing market and the economy in general.

Some of potential buyers are still reluctant to enter the market and are taking a wait and see attitude on prices, while others who would like to move up are struggling to sell their house.

Still, there’s another segment of the population that has been forced out of their homes and are simply not in a position to buy at the current time.

Falling gasoline prices mask rise in core CPI

The CPI, or Consumer Price Index, fell 0.2% in June as expected amid a 4.4% decline in energy prices, including a 6.8% decline in gasoline prices.

Food costs were also well behaved, rising just 0.2% last month, the smallest increase since last December.

But falling energy prices last month masked an overall upward trend in retail inflation.

The core CPI, which excludes the more volatile food and energy categories, rose 0.3% in June, the second such monthly increase in as many months.



Year-over-year, the CPI held steady at 3.4%, while the core CPI edged up from 1.5% to 1.6%.

At 1.6%, core inflation, which has been creeping higher, appears to be relatively well behaved. But the y/y rate does not reflect the recent jump in the broader price level.



Thanks mostly to higher auto and apparel costs, core inflation is up 3.0% at an annualized pace over the last six months, according to government data.

That’s well above the Fed’s implied target of just under 2%! Of course, I'm not comparing apples to apples, i.e., y/y versus a six month annualized pace, but the recent uptick, though transitory in the Fed's view, is a bit troubling.

QE3 chatter
On Wednesday, Fed Chief Ben Bernanke opened the door to another round of monetary easing, offering three different options – two of which have largely been untested.

Stocks reacted favorably but Bernanke dampened enthusiasm on Thursday.

“We’re not prepared at this point to take further action,” Bernanke told a Senate panel yesterday in his Q&A session, per Bloomberg news.

“Today the situation is more complex,” he told lawmakers. “Inflation is higher. Inflation expectations are close to our target.”

With core inflation moving forward at an annualized pace over the last six months of 3%, inflation is up, which is complicating the Fed’s job.

A side note: In my view, the $600 billion in bond purchases between November and June have played a significant role in rising commodity prices (see QE2 and its economic impact – chart 2).

And businesses, which still must deal with fragile aggregate demand, have had some success in passing along higher costs.

So it was not surprising to hear Bernanke put the brakes on QE3 chatter, especially since, there was a two month gap between the first mention of new bond buys and the actual implementation of QE2.

The Fed will continue to closely monitor economic activity, especially job creation. And if we continue to see weak growth, odds of  a policy shift will rise.

Bernanke acknowledges additional options on the table

Fed Chief Ben Bernanke moves to the Senate today after testifying before a House Committee on Wednesday.

Much of the prepared remarks were generally anticipated: weaker-than-expected recovery is probably temporary, spike in inflation probably transitory and weakness in job market, consumer spending and housing were all mentioned.

And of course, recent Fed actions to support the economy were a part of his written testimony.

Bernanke had recently commented that another round of easing by the Fed is unlikely, implicitly suggesting that the hurdle for QE3 or some other type of unconventional easing is quite high.

But yesterday’s comments caught the market off guard, indicating that Bernanke has lowered the bar.

The Fed Chief reiterated that he expects economic activity will pick up during the second half of the year, as factors that have dampened growth subside.

Still, policymakers at the Fed are concerned that the recent weakness could persist, as Bernanke added that the outlook is unusually uncertain.

In his own words, he said, “The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support.”

He went on to list three possible options that remain in the Fed’s arsenal.

1. Provide more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at their current levels.
2. Initiate more securities purchases or increase the average maturity of its holdings.
3. And finally, the Fed could cut the rate it currently pays on bank reserves held at the Fed – 25 basis points – in the hope that it might put downward pressure on short-term rates more generally.

I might add that the Fed hopes a cut in reserve balances would encourage some banks to loosen lending standards and open up to businesses and consumers.  With excess reserves at $1.6 trillion (see QE2 and its economic impact – chart 2), there’s plenty of dry powder in bank vaults to fuel economic activity.

In reality, this shouldn’t have been as surprising as it first appeared since the FOMC minutes out on Tuesday revealed the heightened level of uncertainty among Fed officials.

On the one hand, they offered up a detailed plan for an exit strategy, but some members noted, “The Committee might have to consider providing additional monetary policy stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run.”

Bernanke was quick to admit that “experience with these policies remains relatively limited, and employing them would entail potential risks and costs.”

He’s right and one must ask, “Will such additional stimulus work, or are we in a liquidity trap where extra cash that’s injected into the economy does little to influence interest rates?"

Deflationary risks – extremely small
I disagree with Bernanke’s assertion that deflationary risks might re-emerge.

Oil prices are near $100 per barrel and raw materials in general, though off their highs, remain at a very elevated level. Inflation expectations, which cratered last summer, are more stable this time around, and we're still seeing solid growth coming out of China based on its latest GDP number.

Further, businesses are still grappling with higher input costs, and the uptick in core inflation bears this out.

Nonetheless, the Fed is keenly aware of the uptick in the unemployment rate and the considerable slowdown in job creation.

I had suspected it might take a month or two of weak job growth before the Fed publicly discussed the possibility of a third round of easy, but the troubling slowdown and resulting weakness in hiring has tipped the Fed’s hand.

If I had to take an educated stab at what will eventually happen, weak job creation through July and August seems to be the most obvious path. And that is going to be upper most on the Fed’s mind.

But the uptick in core inflation is troubling and further easing could quickly cause renewed speculation in commodities, putting additional pressure on core inflation.

Still, just telegraphing the possibility to the financial markets suggests at least a 50% chance of some type of shift in policy.  Look for comments from regional Fed officials in the near term for clarity.

Drop in jobless claims may be related to special factors

A drop in weekly jobless claims to the lowest reading in nearly three months would normally be welcome news, not just for job seekers and those worried about layoffs, but Fed Chairman Ben Bernanke, who surprised the markets yesterday with talk that another round of easing is being considered.

But special factors may have played a role.

Weekly initial jobless claims fell 22,000 in the latest week to 405,000, matching the Bloomberg forecast. The 4-week moving average dipped 3,750 to 423,250, while continuing claims edged up 15,000 to 3.73 million.



What might normally be greeted favorably must be looked at somewhat skeptically.

Seasonality is taken into account each week by the Department of Labor but adjustments sometimes get a bit tricky following a major holiday weekend.

Additionally, the timing of auto shutdowns for re-tooling, which takes place each year at about this time, can also skew the data, Bloomberg News pointed out.

Or course, the decent-sized drop is welcome, but let’s wait a couple of weeks and see how this plays out before stating that the downward trend we saw earlier in the year has reasserted itself.

FOMC minutes reveal members discussed the ‘how to’ but not when for an exit strategy

The June 21-22, 2011 meeting of the FOMC – Federal Open Market Committee – met against the backdrop of slowing economic activity, a pick up in core inflation, which it still believes is temporary, and growing fears that one or more countries in Europe might default on their debt.

The FOMC minutes noted that growth in consumer spending has declined, the labor market has softened, and activity in the housing market remains depressed.

Exit stage left
At the conclusion of the meeting, the FOMC decided that when the time comes to begin normalizing policy, it plans to:

1. Stop reinvesting some or all principal repayments
2. Modify its forward guidance on the path of the fed funds rate and initiate temporary reserve-draining operations aimed at supporting the implementation of increases in the fed funds rate when appropriate
3. When conditions warrant, begin raising the target for the fed funds rate
4. Sale of agency securities likely to begin sometime after the first hike in the fed funds rate, with timing and pace communicated to the public in advance
5. Once sales begin, the pace of sales is expected to be aimed at eliminating the holdings of agency securities over a period of three to five years
6. And finally the FOMC stands ready to adjust its exit strategy depending on economic and financial conditions.

The template provides the investing public with guidelines, but there was not indication as to when such an undertaking might begin.

Currently, the Fed is battling a slowdown in economic activity and an acceleration in core inflation.

Further increases in inflation would greatly complicate the Fed’s job of promoting its statutory mandate of maximum employment and price stability.

Commodity prices have jumped, which is fueling the rise in inflation, but wage gains have been stagnant, and excess capacity and subdued demand suggest any further and unwanted gains in inflation are probably not on the horizon.

Additionally, the Committee pointed out that longer-run inflation expectations remain stable.

Most participants expected that much of the rise in headline inflation this year would prove transitory, and inflation over the medium term would be subdued as long as commodity prices did not continue to rise rapidly and longer-term inflation expectations remained stable.

Nevertheless, a number of participants judged the risks to the outlook for inflation as tilted to the upside. Moreover, a few participants saw a continuation of the current stance of monetary policy as posing some upside risk to inflation expectations and actual inflation over time.

But Committee members were divided on what to do.

On the one hand, a few members noted that, depending on how economic conditions evolve, the Committee might have to consider providing additional monetary policy stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run. QE3?

But a few members viewed the increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant the Committee taking steps to begin removing policy accommodation sooner than currently anticipated.

Consequently, the Fed stayed on its expected path, signaling it will hold the fed funds rate at the current level for an extended period and concluded the meeting by stating it will end its planned purchases of $600 billion in Treasuries by the end of June.

Euphoria to despair–weak nonfarm payroll growth throws cold water on ADP report

OK.  That might be a bit of hyperbole on my part, but yesterday’s release by ADP showing a 157,000 jump in private-sector payrolls created a fertile climate for bullish sentiment on the Street.

But today’s report by the BLS that the economy added just 18,000 jobs in June, with 57,000 coming from the private sector, suggests the slowdown in the economy continues to severely hamper job creation.  And the reaction on Wall Street has been swift, with stocks taking a tumble, as investors run to Treasuries.

Details and a more formal look are available at Examiner.



Last week I suggested that forecasts calling for a roughly 100,000 rise in nonfarm payrolls may have been a bit too optimistic.

Weekly jobless claims have been holding in an elevated range, and there have been few signs that the economy was set to emerge from its recent soft patch.

Further, businesses have clamped down on hiring amid the slowdown and will likely keep a cautious eye on their markets before bulking up on staff.



Consequently, the nonfarm payroll numbers provided by the government more accurately reflect the recent economic slowdown in my view.

And we are unlikely to see a much-needed acceleration in hiring any time soon.

Weekly jobless claims edge lower

Weekly initial jobless claims fell 14,000 in the latest week to 418,000, while the 4-week moving average dropped by 3,000 to 424,750. Continuing claims were down 43,000 to 3.68 million.



There has been little change in the rate of jobless claims, which have been holding at an elevated level above 400,000 since April.

In one sense, the recent plateau has been mildly encouraging since this leading indicator of economic activity is not signaling the recovery is about to stall.

However, it’s not suggesting a more vibrant economy is on the horizon either.

Uncertainty is highlighted by falling debt service

Since the start of the recession, the debt service ratio has fallen at its fastest pace in over a quarter of a century.

The reason behind the dramatic decline is fairly simple.  Consumers have cut back on spending and borrowing – we refuse or are simply unable to tap our homes like an ATM machine as we did in the prior decade. And the hurdle to take on new debt for purchases has risen.



Falling interest rates have also been a big help, along with modest repayment of debt and consumer defaults on loans.

In normal times, the extra cash in our wallets might provide the fuel that would power consumer spending and put the economic recovery on a much more solid foundation.

But these are anything but normal times.

Instead, most of us have chosen to save the extra cash.  And we can detect the new-found interest in rainy day funds simply by looking at the rise in the savings rate.

Following the relatively mild 1990-91 recession, it took nearly four years for the DSR to bottom.

This time around, the recession, which was caused by a financial crisis, has has been far more severe.  And contractions that spring from a financial crisis, versus ones caused by high interest rates, historically have produced weak economic recoveries.

To almost no one’s surprise, the recovery this time around has fit that pattern.

Consequently, there is far more uncertainty among consumers, which has slowed spending.  And businesses, which are flush with cash, have been reluctant to hire, taking a wait and see attitude.

All of this suggests we won’t be seeing any surge in growth over the next year or two (or more?) as consumers continue to focus on savings.

One final note: savings and debt service are inversely related with a correlation of –0.67 since 1985, where 1 equals perfect correlation, minus 1 equals perfect inverse correlation and 0 equals no correlation.

Not too surprising.

However, the recent surge in gasoline prices appears to have been mostly financed by savings, which suggests that the pullback in gasoline prices over the past two months, though a psychological boost, may serve only to replenish the modest draw down in bank accounts.

ISM services index eases in June

The lull in economic activity that began a couple of months ago has continued into June according to the latest data supplied by the Institute for Supply Management.

The ISM Non-Manufacturing Index, which measures activity in the broad-based service sector, slipped from 54.6 in May to 53.3 in June, signaling activity in service industries progressed at a slower pace last month.

A reading above 50 suggests the sector is expanding.



Basically, it’s the same story we’ve been hearing about since April when the spike in weekly jobless claims first signaled a soft patch in the recovery was beginning to evolve.

The Fed has acknowledged the recent sluggishness and continues to suggest it is temporary; however, Bernanke recently conceded that policymakers have been unable to pinpoint the exact causes and have admitted they do not have a quick remedy at their disposal.

The tragic earthquake that struck Japan in March has caused disruptions in the global supply chain, which has impacted the recovery.

But the general uncertainty in the economy, weakness in housing, slow job creation and tight credit standards have all played a role.

If there is one bright spot – which in some respects, is just a reflection of latest slowdown – prices eased from 69.6 to 60.9.

Still, the data are not signaling the onset of a new recession.

QE2 and its economic impact

The Fed’s controversial and much-maligned program to buy $600 billion in longer-term Treasuries, popularly known as QE2, came to an end last week as the central bank made its final purchases of bonds.

The decision by the Fed to launch into a second round of bond buys came in early November, but Fed Chief Ben Bernanke first publicly toyed with the idea at the end of August.


Source: Bloomberg, Federal Reserve

Last summer, the economy was suffering through an economic slowdown and talk of a nasty bout with deflation was rising.

In order to stimulate economic growth, boost inflation expectations and erect a deflationary firewall, the Fed eventually decided to implement a round of bond purchases that would boost liquidity by hundreds of billions of dollars.

Stocks prices reacted favorably but the extra cash also seems to have founds its way into commodities (chart above).

Currently the core CPI is running at an annualized pace of 3.0% over the last three months.



But has the extra cash founds its way into the real economy?

The second chart would strongly suggest it has not.

Excess reserves, defined as funds that are over and above what banks must hold in order to satisfy withdrawal needs of their customers, have soared by about $600 billion – in line with the extra cash the Fed created to buy its Treasury bonds.

Reserves stood at nearly $1 trillion before QE2 was implemented, and it should come as no surprise that the additional liquidity has done little to bolster the real economy (see Excess reserves and heightened uncertainty – Sept 27, 2010).

Liquidity trap?  If we’re not there, we sure are close.



No matter how much money the Fed floods into the economy, the central bank is unable to affect interest rates, i.e., a liquidity trap.

Bulls regain composure

What a difference one week makes, as the bulls came up winners for five consecutive days!

Underscoring last week’s triumph, the Dow Jones Industrials gained nearly 650 points, the biggest weekly point gain since the index of 30 industrials climbed 782 points at the end of November 2008 (MarketWatch).

Talk that some European countries might just roll over maturing Greek debt and the eventual passage of a tough and unpopular list of budget cuts in the Hellenic Republic, which paved the way for new aid, helped avert a near-term default and sparked a big rally in stocks last week.

And relatively sanguine economic data – though nothing to suggest a renewed economic vigor – also aided the advance. Simply put – mix in reasonably decent economic news with a healthy dose of bearish sentiment and you concoct a recipe for an explosive rally.

Victims during the week – Treasuries were hit, with the ten-year yield jumping nearly 30 basis points to 3.18%. The dollar didn’t fare very well either amid a move to riskier assets.

In the meantime, barely a hiccup was registered in credit markets before and during the recent debt crisis if measures of risk are taken into account, suggesting a temporary resolution had been anticipated by banks and bond players – something I’ve harped on over the past three weeks.

Looking forward, investors and analysts will be paying close attention to economic data in the holiday-shortened week and the less-than-robust recovery could provide headwinds for equities.

All eyes will be on the labor report out on Friday, which is expected to show an increase of 110,000 new jobs in June, up from a disappointing 54,000 in May (Bloomberg). The private sector is forecast to add 125,000.

I’ll go out on a limb and say that 110,000 may be a bit optimistic. And 100,000+ is far from impressive. But anything in that neighborhood would likely ease fears that the latest turbulence and continued uncertainty isn’t forcing firms to shelve recent plans to bolster staff.

ISM Manufacturing shows unexpected improvement

An unexpected rise in the ISM Manufacturing Index suggests the recent slowdown in the goods producing sector may be coming to an end.

The national look at manufacturing accelerated from 53.5 in May to 55.3 in June, the 23rd straight month of expansion.  A reading above 50 is an indication that manufacturing activity is moving ahead.



But the good news (a sigh of relief might be a better way to describe June’s increase) must be tempered by the fact that a jump in inventories was responsible for much of the gain – 48.7 to 54.1.
Nothing worrisome but worth noting.

New orders and production did rise slightly, suggesting stability, but the increase in inventories may hamper production down the road.

Meanwhile, costs are still a burden for most manufacturers.  Gasoline and a host of commodities have dropped in price but prices paid managed just a modest decline of 8.5 points to 68.0.

Despite the modest concern from some of the internals in the survey, stocks viewed the report in a favorable light and rallied following the release of the index.

All in all, today's report is just the latest indicating that the recovery still has legs.  Short legs, but nonetheless, we're still moving forward.

Jobless claims hold in narrow path

Weekly jobless claims fell 1,000 in the latest week to 428,000 and have now held in a very narrow range – 420,000 to 430,000 for six consecutive weeks. As a result, the 4-week moving average barely moved, rising by just 500 to 426,750.



The lack of any significant upward are downward movement in jobless claims, following a brief dip earlier in the year below 400,000, is telling us that the economy continues to slowly improve.

Based on the release as well as recent trends, no new recession is on the horizon but any pick up in economic growth is unlikely, either.

Simply put jobless claims are still elevated, underscoring the uncertainty many of us feel regarding what’s happening in the economy.

Despite the lack of any signs of an acceleration in economic activity, the Chicago Purchasing Managers Index, which looks at manufacturing activity in the Midwest, unexpectedly rose in the latest month.



A possible pick up in auto production tied to an easing of the supply chain disruption from Japan that followed the tragic earthquake that hit the nation earlier in the year might explain the welcome rise in the index.

Both production and new orders surged, while inventories tumbled.  Unfortunately, prices paid eased slightly but remained at a worrisome level, which is somewhat surprising given the recent fall in commodity prices.

Nonetheless, the Chicago PMI tends to be a rather volatile index, and other measures of regional manufacturing have slowed significantly.

We’ll get a better read when the ISM Manufacturing Index is released on Friday.

Slower growth pressures consumer confidence

Sometimes just waiting a day or so to let a particular release marinate allows us to gain a bit of perspective. Fed releases and unemployment data come to mind.

But I wouldn’t preclude a day-late look at the Conference Board’s survey of consumer confidence either.

The Consumer Confidence Index fell 3.2 points in the latest month, which makes the dip in June the third decline in four months. Clearly, not a trend that is welcome by Fed officials and investors.

The economic data are still pointing to a growing economy, but the heightened level of uncertainty that has been clouding the outlook has been taking a toll on sentiment in recent months.

Job creation slowed considerably in May, jobless claims are up, manufacturing activity has moderated, the housing market remains in the doldrums and many refuse to throw caution to the wind whenever they go online or shop at their local retailer.

Of course, gasoline prices are well off the early May highs, but at over $3.50 per gallon in most locales, a fill up still takes a considerable bite out of our wallets.

Until economic activity re-accelerates – and it still appears that the latest economic bump in the road will be short-lived – consumer confidence will probably remain under pressure, and caution will prevail at the nation’s malls.

Consumer spending hits a bump in the road

The government reported this morning that consumer spending was unchanged in May, highlighting the slowdown in job growth and the uncertainty in consumer sentiment.

Personal income managed to rise 0.3% and the savings rate increased a tick to 5.0%.

Removing the impact of inflation, real consumer spending actually declined by 0.1%, the same as April. 

Moving over to inflation, the PCE Price Index was up 0.2% last month, but the core rate, which excludes food and energy, rose by 0.3%, signaling that the steep jump in commodity prices is slowly beginning to leak into goods and services.

Summarizing the data-heavy, number’s-heavy report simply confirms what we’ve already known – growth has slowed but has not stalled.

IEA oil release hammers prices– at least in the short term

The surprise announcement today by the International Energy Agency (IEA) that its member countries – 28 in all – will release 60 million barrels of oil from storage over the next 30 days took a heavy toll on prices, knocking the cost of crude briefly below $90 per barrel.

That’s good news for consumers – at least short term as the IEA’s press release appears to have had its intended effect.

But all is not OK in the world oil markets.

First, the move almost smacks of desperation, as the world economy slows under the pressure of weak U.S. growth, debt worries in Greece and a modest slowdown in China.

An interesting and unsettling side note: stocks did not react favorably to the drop in crude prices, and instead continued to a sell-off that was tied to Bernanke’s sobering economic remarks made yesterday afternoon.

Second, the unrest in Libya has taken about 132 million barrels of light, sweet crude off the market up through the end of May per the IEA.

And despite talk by Saudi Arabia that it would make up the difference, the announcement suggests otherwise.

But the temporary increase in oil production is just that – temporary, and it’s possible that a further downward slide in prices could be met by a quiet cutback in OPEC or Saudi production.

Moreover, the US market is well supplied with crude at the present time, as the chart from the EIA reflects.



Consequently, the pullback in prices may turn into a more temporary phenomenon.

Additional supply disruptions or still weaker economic growth will very likely have more of an impact on prices down the road than today’s news.

New homes for sale at record low

The number of new homes for sale on the market slipped to a record low in the latest month, according to data supplied by the Commerce Department.

The actual number of new homes on the market fell from 172,000 in April to 166,000 in May, the lowest number since the government began tracking new home sales in 1963.



But sales have been in the basement, and 166,000 actual homes for sales represents a 6.2 months supply. That’s well below the January 2009 high of 12.2 months but in line with the average over the past 40+ years of 6.2 months.

Further, the 166,000 figure is not adjusted for the much larger population we have today versus the 1960s!

But it’s clear that all is not sound with the new housing market.  Builder confidence remains very low, explaining the lack of production and apparently tight inventory of new houses.

And competition from distressed sales of late model homes and the shadow inventory that remains over the market are offsetting any tailwinds that might assist new builders.



Still, falling supplies seem likely to set the stage for an eventual recovery in the new home market.

In the meantime, sales of new homes fell 2.1% to an annual pace of 319,000 in May.

Sales aren’t showing any signs of recovering and instead, or holding near the bottom.

Weekly jobless claims camp out on a plateau

Bloomberg News cited “technical issues” that forced the Labor Department to estimate claims in six states as a possible reason  for a troublesome 9,000 increase in weekly initial jobless claims to 429,000 in the latest week.



The 4-week moving average held steady at 426,250, and continuing claims were practically unchanged at 3.7 million.

Nonetheless, weekly jobless claims are holding well above 400,000 following a brief dip below the key psychological level.  And the elevated level highlights the uncertainty in the economy and the reduced pace of the recovery.

Fed cuts forecast on GDP, as Bernanke comments pressure stocks

"You're on your own"

There weren’t any big surprises to come out of the Fed’s press release that followed the conclusion of its two-day meeting.

The FOMC acknowledged the slowdown in the economy, telegraphed that interest rates aren’t going higher anytime soon, will no longer expand its balance sheet and believes the growth will eventually accelerate. A cut and dry look is available at Examiner.


(Source: Fed)

Further, the Fed also cut its forecast on GDP growth for the second time this year.  Unfortunately, the FOMC expects unemployment to remain uncomfortable high through the end of 2013.


(Source: Fed)

What did seem to catch the markets off guard occurred in the press conference that followed the FOMC meeting.

The Fed noted in its press release, “The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan.”

'In part' implies there were other factors impacting the economy and an astute reporter quickly picked up on this, asking what else might be responsible for the sluggish recovery.

Bernanke responded that monetary officials don’t have a precise read as to why slower pace is persisting. But some of the headwinds that are of concern included “weakness in the financial sector, problems in the housing sector, balance sheet and deleveraging issues.”

He added that some of these headwinds may be stronger and more persistent than “we thought.”

Of course, questions about Europe and Greece surfaced and the potential impact on the U.S.

Bernanke said the Fed has been “very assiduous” in examining the exposures financial institutions have countries that have been plagued by debt issues.

U.S. banks are not significantly exposed to those countries, including Greece, as direct exposure is “pretty small.” Exposure is larger in the more stable countries, such as Germany and France.

The same holds true with money market funds. Exposure is minor in peripheral countries but there is substantial exposure in European banks in so-called core countries, Germany, France etc.

Not surprisingly, Bernanke said a disorderly default would “no doubt roil financial markets globally would have a big impact on credit spreads (thus far, its been minor), stock prices and so on. Effects in US would be quite significant.”

It’s the disorderly default the Fed is hoping to prevent.

Bernanke to economy: You're on your own
Well, Bernanke didn't utter those words, but one has to ask, "What has the Fed chairman done?"

Bernanke took credit for eliminating the small but growing threat of deflation that was emerging last summer and noted that job creation picked up amid the QE2 bond purchases.

Other than that, the Fed chairman seemed more like a deer in the headlights, conceding that growth is slowing and some of the causes may be more than temporary.

He offered little solace to those of have been heavily impacted by job losses or those who've yet to see stock and retirement portfolios fully recovery from the 2008-09 bear market.

In other words, monetary policy has its limits.

Credit markets seem to yawn amid investor worries about Greece

The recent slide in stocks has been blamed on a slowing economy and fears that Greece will soon default on its debt, potentially causing problems in other wobbly European countries which could quickly spread to the U.S.

Credit default swaps (insurance on debt) on financials have risen (IMF), and the slowing economy and a flight to quality have pushed the yield on the ten-year Treasury below 3% and the yield on the two-year note to its lowest level on record – 38 basis points. 

But a look at measures of risk in the credit markets suggest are painting a different picture – calmer waters and few fears that a jarring default might be around the corner.



The two-year interest rate swap spread on Treasuries soared during the Lehman fiasco, and once again we saw some frayed nerves when problems in Greece first surfaced a year ago.

But the latest flare-up and rating agency downgrades have caused little more than a ripple. Further, the three-month LIBOR rate is currently sitting at 25 basis points, just one tick below a record low.

Both indicators are revealing that there is ample liquidity in the financial system, and banks aren’t hoarding funds the way they did in the fall of 2008.

Existing home sales slip to six-month low

A drop in existing home sales to a six-month low in May is highlighting the recent slowdown in the recovery.

Existing home sales fell 3.8% to a seasonally adjusted annual rate of 4.81 million in May from a downwardly revised 5.00 million units in April. That’s 15.3% below a year ago when the home buyer tax credit distorted the market and shifted sales into the spring from the summer.



Additionally, the National Association of Realtors reported that the total supply of houses available based on current sales increased from 9.0 months to 9.3 months.

May’s numbers as well as the recent trend in existing home sales, which make up over 90% of total sales, reveal that there just hasn’t been much good to say about the current state of housing.

Potential buyers either can’t move because their current home has no equity or they are worried about the direction of home prices.  And historically low interest rates have done little to spark any interest.

And as the chart above suggests, the recent rise in inventory could put additional pressure on prices.

Unfortunately, I’ll end this post on a downer: last month’s pending home sales number suggested a big drop in sales is on tap for the current month.

Macro economic events still dominate

Fed on tap

Investors have been reeling from one piece of bad economic news after another. That’s why a couple of releases that didn’t surprise to the downside was enough to capture the attention of the markets, helping the Dow Jones Industrials and the S&P 500 Index, which have been starved for good news, squeak out gains and snap a six-week losing streak.

First, retail sales in May managed to barely exceed reduced expectations, strongly hinting that debt- and recession-weary consumers are not heading back into their post-Lehman Brothers’ caves.

Second, weekly jobless claims remain elevated, but a drop last week is a strong indication that economic activity isn’t grinding to a halt. A rebound in the Leading Index is also suggesting that the slow and uneven expansion is not petering out.

But action across the Atlantic has not gone unnoticed, as another downgrade of Greece by Standard & Poor’s and fears that there will be an eventual default of some kind has had a mixed impact on the credit markets.

The flight to safety continues, with the yield on the ten-year benchmark Treasury back below 3%, while the yield on the two-year note fell under 40 bp, a record low!

The euro has also come under pressure amid fears that the problems in Greece could affect other wobbly nations on the continent. And CDSs (insurance on debt) on financials have risen. Defaults beyond Greece could also do damage to banks and institutions in the USA that hold debt instruments from those countries.

Interestingly, however, measures of risk in the credit markets – three-month LIBOR and the two-year interest rate swap spread – have barely reacted to the latest crisis, seemingly suggesting a “business as usual attitude” among the players in the credit markets.

We did finally see a fairly noticeable uptick in the swap spread this week, but we’re far off the post-Lehman levels and well below what we saw last year before the first bailout of Greece (see chart below).



Moreover, the LIBOR is holding just above a record low.

Fed's up
Next week brings us to the latest in existing home sales, but the two-day Fed meeting, which concludes on Wednesday and the second-ever press conference from Fed Chairman Ben Bernanke’s will get heavy play.

It’s always a bit dicey trying to outguess the Fed, but I suspect that policymakers will acknowledge that the recovery has slowed, job growth remains painfully slow, and it will reiterate that the recent uptick in inflation is transitory.

There have been no hints that the Fed will extend QE2. Rates won’t change, and it seems unlikely that the Fed will come close to hinting at any rate hike.

Leading Index signals slow growth through the fall

The Leading Economic Index put together by the Conference Board jumped a surprisingly strong 0.8% in May, following a 0.4% decline in April, and a 0.7% increase in March.

“Modest economic growth is being buffeted by some strong headwinds, including high gas and food prices and a soft housing market. The economy will likely continue to grow through the summer and fall, however it will be choppy, Ken Goldstein,” an economist with the Conference Board said.

Although I’m not in the camp that believes a recession is imminent, May’s upbeat reading must be tempered by some of the components that drove the outsized gain.

The largest contributions came from the interest rate spread, consumer expectations, building permits and real money supply.

Interest rate spreads and money supply are extremely intangible, while consumer expectations in May were mixed and housing continues to struggle.

In the meantime, consumer sentiment, as measured by the University of Michigan’s survey, unexpectedly fell from 74.3 in May to 71.8 for the mid-June reading.  A survey by Bloomberg had called for 74.5.



Consumers sentiment remains in a downward trend amid weak job creation and elevated jobless claims.

Though prices have receded somewhat, the spike in gasoline prices earlier in the year has also been a negative, while uncertainty in housing is likely playing a role in depressing sentiment.

Philly Fed survey reveals additional weakness in manufacturing

Price pressures are moderating

Two relatively good reports today, now for the bad news.

Rounding out a very busy day of economic data (and for that matter, a very busy week and we still haven’t made it to Friday), the Philly Fed’s Index of Business Activity is signaling that the weakness that has cropped up in the once hot manufacturing sector is continuing into June.


Source: Philly Fed

The survey that looks at manufacturing in the mid-Atlantic region fell from 3.9 in May to –7.7 in June, the first negative reading since last September. A level of zero suggests the sector is neither expanding nor contracting.

New orders slipped into negative territory, while the future general activity index decreased 14 points this month and has now dropped 61 points over the last three months.

National manufacturing has been hurt by the supply chain disruptions brought on by the earthquake in Japan.

But autos and auto parts play a very small role in the mid-Atlantic region, as Goldman Sachs calculates the share of auto production in the region covered by the Philly Fed survey is just 1.1% and 1.9% for the Empire State – the New York survey – per MarketWatch.

In a reflection of weaker activity, prices paid fell from 48.3 to 26.8, and prices received, which is an indicator of how well manufacturers are able to pass along higher costs, dropped from 16.8 to 4.4.

Like the Empire survey, the slowdown in the economy is taking the focus away from inflation, especially as firms find it more difficult to boost prices.

And the apparent shift in pricing power away from manufacturers is occurring just as core inflation has begun to heat up.

Yesterday, the CPI increased by a modest 0.2%, but the core rate of inflation rose 0.3%, the first such rise in almost three years, as higher commodity prices begin to work their way into the broader price level.

The Fed believes any inflation will be transitory, as demand has not been robust and wages, the largest expense for most businesses, have been stable.

Housing starts slowly move ahead

Headwinds still strong

Builder confidence remains in the basement, but housing starts inched up by 3.5% in May to a seasonally adjusted annual rate of 560,000.

Building permits, which is a more forward looking indicator of new construction, rose by a more impressive 8.7% to 612,000 units, the highest in five months. Much of the lift, however, came from multi-family units, but single-family managed a 2.5% gain to 405,000.



On a relative basis, the overall news is encouraging as single-family permits, which offers us an early look at the new home market, has been up for three months in a row.

And despite the overall downward trend over the last year, permits have not returned to the bottom reached in early 2009.



Still, plenty of obstacles remain before a firm foundation is in place under the market.

Competition from distressed sales of late model homes, tight credit standards, difficulty in selling existing homes, fears that housing prices haven’t bottomed, weak job creation and the inability of those who have lost homes to qualify for a new home are all standing in the way of a stronger housing market.

So it shouldn’t come as a surprise that builders have yet to express any degree of optimism on the market.

Weekly jobless claims at four-week low

In what has to be a disappointing report for those who have been very bearish on the economy, first time filers for unemployment claims unexpectedly fell to a four week low.

Weekly jobless claims declined by 16,000 to 414,000, and the 4-week moving average was unchanged at 424,750. Continuing claims dipped 21,000 to 3.68 million.

Weekly jobless claims snuck above 400,000 in early April, was one of the first warning signs the economy was headed for a bump in the road, and has held above the key psychological level ever since.

Yes, we’re still above 400,000, highlighting the fragile and slow recovery from the worst recession in over 70 years.

But the larger-than-expected drop and recent stability in this key measure of activity is among the clearest indicators that the economy is not headed back into another slump.

Impact from commodity prices showing up in the CPI

Job creation has generally been weak and the economic recovery has been slow and uneven, but the latest data on inflation suggest that high raw material prices are showing up at the nation’s retailers.

The Consumer Price Index (CPI) increased 0.2% in May, as a 0.4% rise in food was offset by a 1.0% drop in energy prices. Core inflation, however, exceeded the headline rate for the first time in a year, rising 0.3%, the fastest pace since July 2008.



Year-over-year, the CPI increased from 3.1% in April to 3.6% in May, while core inflation – that is, inflation without food and energy – rose from 1.3% to 1.5%.

At 1.5% core inflation is holding below the Fed’s implied target of near 2.0%, but the y/y rate is not completely capturing the recent though modest burst in inflation.

According to government data, the core CPI is up at a seasonally adjusted annual rate of 2.6% over the last six months and is up a more worrisome 3.0% over the last three months.

That’s well above what the Fed or most economists would consider to be price stability!

Blame the surge in commodity prices, especially in metals, for the jump in core inflation.

Fed Chief Ben Bernanke believes the the spurt in commodity prices will be transitory, and raw materials have leveled out lately.

Further, inflation expectations have diminished, while slack in the economy, muted wage gains, and sluggish demand have helped to counter inflationary trends brought about from surging raw material costs.

But that hasn’t prevented some businesses from taking advantage of nascent pricing power and passing along some of the higher costs to consumers.

Recent economic weakness has taken the focus off inflation, and the latest soft patch, coupled with the end of the Fed’s QE2 program this month, should help to minimize the impact of rising costs in the economy.

A look behind the latest industrial production figures suggests modest growth

Industrial production grew by just 0.1% in May following no gain in April. Capacity utilization held steady at 76.7% – yes, there’s still slack in the economy and that’s helping to minimize the impact higher commodity prices have had on inflation.

But looking behind the latest numbers, the sector is not fairing as poorly as the headline figures might suggest – or how the New York Fed’s survey indicated this morning.

Held down by falling utility production, manufacturing ex-energy grew by a respectable 0.5%, more than erasing April’s drop of 0.4%.

We’re continuing to see the lingering impact from the earthquake in Japan on the auto industry, but if we remove both energy and autos (that leaves us with almost two-thirds remaining) production increased by 0.6%, the best reading since January.

Overall, the data were encouraging.

More bad news on manufacturing

The Empire Manufacturing Index provides an early look at manufacturing during the current month. It’s a sliver of the sector since it deals with New York state only and it can be volatile, but again, it gets attention because it’s first.

Unfortunately, the sector received some bad news as the Empire survey showed the industry contracted for the first time since November 2010, falling from 11.9 in May to –7.8 in June.

Empire Manufacturing Index

Source: NY Fed

More bad news: new orders and shipments both fell sharply and both fell into negative territory.





About the only good news, which in essence is a reflection of weaker conditions, showed up in the prices portion of the report.


Source: NY Fed

Slower growth is relieving some of the upward pressure on commodities, and manufacturers are finding it increasingly difficult to pass along higher costs because of slower demand.

The ISM Manufacturing Index for May confirmed the sluggishness in the once hot sector and early signs from the current survey suggest continued weakness.

But this is a narrow look at goods producers, and we’ll get a better picture tomorrow when the Philly Fed survey is released.