|
The focus last week was on the Fed’s surprise rate cut, the pending fiscal stimulus package, and earnings announcements. While the Fed’s interest rate cut and progress on the stimulus package helped equities pull out of free fall at mid-week, earning reports from the financial sector at week's end weighed on equities. The markets are counting on additional rate cuts by the Fed both at month end and during the next few months.
Except for techs, equities finally had a net gain for a week for the first time this year. The holiday shortened week started badly with a huge sell off on Tuesday despite a pre-open rate cut by the Fed of 75 basis points. Overseas markets had fallen sharply on Monday and caused worries about the global economy which fed into negative sentiment on Wall Street. Tuesday’s losses likely would have been worse without the fed rate cut. Techs were hardest hit. Apple’s revenue guidance was well below forecasts. Stocks bounced back big time on Tuesday as the Dow posted a gain just shy of 300 points. Financials led the rebound with many seeing Tuesday’s sell off as the bottom of a correction. Also helping were reports that New York regulators and banks were discussing ways to support bond insurers which are rumored to soon lose their AAA credit rating. Short covering also boosted Wednesday’s rebound. Stocks were boosted on Thursday primarily by news that the administration and House leaders had reached a deal on a fiscal stimulus package. The two-session rally ended on Friday as the financial sector was spooked by an announcement by Goldman Sachs that it was laying off 5 percent of its workforce. Other sectors fell as some investors went into profit taking mode and others worried over yet to come subprime losses. Friday ended a down day despite good earnings from Microsoft earlier in the morning.
Last week, major indexes were most up, with techs being an exception: the Dow, up 0.9 percent; the S&P 500, up 0.4 percent; the Nasdaq, down 0.6 percent; and the Russell 2000, up 2.3 percent.
Since year end, major equity indexes are still down. Major indexes are down as follows: the Dow, down 8.0 percent; the S&P 500, down 9.4 percent; the Nasdaq, down 12.3 percent; and the Russell 2000, down 10.1 percent.
Treasury yields declined last week with the near end falling the most, pulled down by the Fed’s 75 basis point cut in the fed funds target rate. The 3-month T-bill dropped 54 basis points, indicating that some of the Fed’s rate cut had already been built in. Yields on long bonds only dipped slightly with inflation concerns keeping rates up. During the remainder of the week, rates generally followed the stock market as funds flowed from fixed income to equities during the stock markets’ two strong days on Wednesday and Thursday. Rates fell by double digit basis points on Friday as equities gave up significant portions of the prior two days’ gains. Net for the week, the yield curved steepened sharply with T-bills and the 2-year T-note down notably. The drop in the 2-year rate heavily reflects a market belief that the Fed will be cutting rates further in coming months.
Treasury yields were down across the yield curve as follows: 3-month T-bill, down 60 basis points, the 2-year note; down 18 basis points; the 5-year note, down 8 basis points; the 10-year bond, down 8 basis points; and the 30-year bond edged down 2 basis points.
Since year end, the 2-year T-note has fallen 88 basis points while the 10-year T-note declined 48 basis points. The 3-month T-bill is down a dramatic 99 basis points since December 31.
Oil prices were little changed net this past week. The only notable price swings were on Wednesday and Thursday. The spot price for West Texas Intermediate fell $1.87 per barrel on Wednesday to $87.98 on fears of recession in the U.S. But prices rebounded $2.08 per barrel to $90.06 barrel on news of agreement between the Bush Administration and House leadership on a fiscal stimulus package that was seen as boosting the U.S. economy.
The spot price for West Texas Intermediate nudged up $0.12 per barrel net for the week to settle at $90.39 per barrel, $9.23 below the record high of $99.62 set January 2nd.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
This past week saw little economic data. The big news, however, came from the Fed with a surprise rate cut before the markets opened in the U.S. on Tuesday. Also, the latest data indicate that housing appears to still be searching for a bottom.
On January 22, the Fed unexpectedly cut the Fed funds target rate by a whopping 75 basis points and at an unscheduled emergency FOMC meeting, leaving the target rate at 3.50 percent. Since August, the Fed has cut the fed funds target rate four times and by a cumulative 175 basis points. The Fed also lowered the discount rate by 75 basis points to 4.00 percent.
According to the Fed, the FOMC cut the target rate “in view of a weakening of the economic outlook and increasing downside risks to growth.” The Fed also noted that the housing sector continues to worsen and that labor markets were softening.
While these are the official reasons the Fed eased, these reasons do not justify the timing of the rate cut in between scheduled FOMC meetings. If these were the only reasons to cut, the Fed certainly could have waited until its scheduled meeting ended on January 30. The real reason likely included the melt down in equity markets in Asia and Europe and concern that equities would freefall in the U.S. without Fed intervention.
No sooner had the Fed cut rates on Tuesday morning that the fed funds futures market called for another rate cut by the Fed at the upcoming January 29-30 FOMC meeting.
The futures market now expects the Fed to cut the fed funds target rate by 50 basis points on January 30 to 3.00 percent and expects the Fed to cut the rate to 2.25 by the end of August of this year. The futures market expects the Fed to keep the target rate at 2.25 percent for the rest of the year.
But where do these rate cuts leave monetary policy in real, inflation-adjusted terms? If the Fed does not ease any further (including on January 30), the inflation adjusted fed funds rate stands at about 1-1/4 percent using the November figure for the core PCE price index year-on-year inflation rate. Using the total PCE price index inflation rate, the real fed funds rate is zero. If the Fed cuts the fed funds target rate by 50 basis points on January 30, the real rate will be somewhere between minus one-half percent and plus one-half percent. These rates certainly should be juicing the economy in coming months but such rates raise the issue of whether inflation will be coming down.
If the Fed cuts rates as the markets expect during the rest of 2008, the real fed funds rate will be substantially negative unless inflation rates fall sharply. A realistic assessment of real rates is that the Fed will not cut rates as much as the markets currently expect and/or the Fed will be making a U-turn in the fed funds target rate toward year end. Otherwise, the Fed is likely setting up another bubble in various markets.
This past both Democratic and Republican leaders in the House and President Bush announced support for a $150 billion package split between $100 billion for individuals and $50 billion for businesses. Individuals will receive $600 and married couples $1,200 plus $300 for children. However, high income households are likely to get little or no rebate with an individual income level of $75,000 being discussed as a phase out level. Small businesses will be allowed to double their write-off for new investments. However, senate leaders have yet to agree to the bill and are talking about adding other features to the fiscal stimulus package, such as extending unemployment benefits. Currently, the best estimate for when households can expect to receive a rebate check is May. However, if the details of the rebates are clear enough for individuals to determine whether they will receive a rebate check, count on many households to pre-spend the rebate check with credit card purchases.
The recent decline in interest rates has yet to boost home sales. Existing home sales fell 2.2 percent in December to a 4.89 million annual rate – record low for this data series that goes back to January 1999. Year-on-year sales are down 22 percent with weakness spread evenly across regions.
A key statistic from builders’ perspective is the supply of homes for sale. Supply slipped back to 9.6 months from 10.1 months in November but the December figure is still quite bloated. Supply in December 2006 was 6.6 months and at the time was seen as being on the high side. The supply overhang is still having only a mild effect on prices, with the median price down 1 tenth in the month to $208,400 for a 6.0 percent year-on-year decline. However, this moderate decline may be due a feature of the median price. Sales of low end housing have fallen off more than high end housing, artificially supporting the median price.
The Fed is quickly running out of room to cut interest rates much further. Should the markets get their wish that the Fed cuts the fed funds target rate by 50 basis points, then the real fed funds rate will be somewhere between negative one-half percent and positive one-half percent, depending on your definition of inflation. While the fed funds futures market is baking in a 2-1/4 fed funds rate by August, a realistic assessment suggests that is not likely. Hopefully, the Fed realizes that it is partly to blame for the housing bubble, as it was too loose with money after the 2001 recession, and will not repeat the same mistake this time while trying to avert a 2008 recession — which many see as being averted, but barely.
This coming week brings a boat load of economic indicators. Market moving indicators include: durables orders on Tuesday; GDP and the FOMC announcement on Wednesday; personal income on Thursday; and employment and ISM on Friday. Plus, we get a number of second tier indicators, including new home sales on Monday.
New home sales in November fell 9.0 percent to an annualized pace of 647,000, the lowest level since 1995. The year-on-year level of sales has plummeted to minus 34.4 percent. The big issue to get housing construction back up is to get supply down. But supply is still weighing on starts with new homes on the market at 9.3 months. Supply a year ago was at 6.5 months.
New home sales Consensus Forecast for December 07: 0.645 million-unit rate
Range: 0.600 million to 0.700 million-unit rate
Durable goods orders have been on a down trend. Durable goods orders slipped 0.1 percent in November, following a 0.5 percent drop in October. New durables orders have fallen for four consecutive months. Markets should watch this indicator closely — durables orders typically lead changes in the business cycle.
New orders for durable goods Consensus Forecast for December 07: +1.6 percent
Range: -0.1 percent to +5.0 percent
The Conference Board's consumer confidence index dipped to 87.3 in November from October's already soft 95.2. According to the Conference Board’s monthly report, the decline was due to high gas prices and home-heating bills. While the slippage in confidence is a concern to the Fed in terms of whether the economy is headed for recession, this report also should worry the Fed about inflation trends. Inflation expectations for 12 months out jumped six tenths to 5.7 percent, no doubt reflecting higher gasoline and heating oil prices.
Consumer confidence Consensus Forecast for December 07: 87.5
Range: 80.0 to 89.0
Real GDP in the third quarter came in at a robust annualized 4.9 and followed a 3.8 percent increase in the second quarter. But the economy slowed sharply in the fourth quarter due to a softer consumer sector adding to a continuing decline in housing. Markets are expecting a very weak fourth quarter but it is not just the overall number that matters — markets will be picking apart the details for signs of imbalances that might tip the economy closer to recession. Also, the inflation numbers will get close scrutiny. The third quarter GDP price index was modest at an annualized 1.0 percent but oil prices have gone up sharply since. The core PCE price index rose an annualized 2.0 percent in the third quarter. The Fed will be concerned about price indexes that come in too strong.
Real GDP Consensus Forecast for advance Q4 07: +1.2 percent annual rate
Range: +0.4 to +1.9 percent annual rate
GDP price index Consensus Forecast for advance Q4 07: 2.5 percent annual rate
Range: +1.8 to +3.9 percent annual rate
The FOMC announcement for the January 29-30 FOMC policy meeting is expected to result in another cut in the fed funds target rate. The Fed is still coming off a rare emergency rate cut in between scheduled meetings on January 22. With the Fed having cut the fed funds target rate by 175 basis points from 4.25 percent in early August to the current 3.50 percent, how much “ammunition” will the Fed be willing to use so soon? And will the markets overreact if the Fed cuts less than expected?
FOMC Consensus Forecast for 1/30/08 policy vote on fed funds target: 3.00 percent
Range: 76 percent probability for a 50 basis point cut to 3.00 and 24 percent probability for a 25 basis point cut to 3.25 percent based on fed funds futures on January 24
Personal income rose 0.4 percent in November, following a 0.2 percent boost in October. Through November, consumers had been getting respectable income gains with the November year-on-year gain at 6.0 percent. However, employment growth slowed sharply in December and could be pointing toward a slowing in personal income growth. Spending was strong in November with personal consumption surging 1.1 percent. That is likely to change in December as retail sales for December fell 0.4 percent, although some of that weakness was related to a temporary decline in gasoline prices. On the inflation front, the overall PCE price index jumped 0.6 percent in November, up from a 0.3 percent increase in October. However, the core PCE price index rose 0.2 percent in November, the same as for the prior month.
Personal income Consensus Forecast for December 07: +0.4 percent
Range: +0.2 to +0.5 percent
Personal consumption expenditures Consensus Forecast for December 07: +0.1 percent
Range: 0.0 to +0.3 percent
Core PCE price index Consensus Forecast for December 07: +0.2 percent
Range: +0.2 to +0.2 percent
Initial jobless claims continue to portray a robust labor market as initial jobless claims slipped 1,000 in the week ending January 19 to 301,000. There were no special factors in the week. But if the economy is headed into recession, a rise in claims will likely be an early warning signal.
Jobless Claims Consensus Forecast for 1/26/08: 318,000
Range: 310,000 to 340,000
The employment cost index for civilian workers rose a moderate 0.8 percent in the third quarter (not annualized) for a year-on-year rate of 3.3 percent. These numbers have been very steady over the past year despite what has been a moderately tight labor market. Federal Reserve officials pay extra close attention to the ECI report for the slightest indication of wage or benefit pressures.
Employment cost index Consensus Forecast for Q4 07: +0.8 percent simple quarterly rate
Range: +0.7 to +0.9 percent simple quarterly rate
The NAPM-Chicago purchasing managers’ index has been a little stronger than other regional indexes, rising to 56.6 in December from 52.0 the month before. In the latest month, both new orders and backlog orders were surprisingly strong. Prices paid improved somewhat while still remaining high, slipping to 63.8 from 76.2 in November.
NAPM-Chicago Consensus Forecast for January 08: 52.0
Range: 50.0 to 53.0
Nonfarm payroll employment came in very weak in December with a near-flat gain of 18,000, following an increase of 115,000 in November. The economy is giving mixed signals on where employment might be headed. Most measures of production (such as industrial production and housing starts) indicate lower demand for labor. Yet, initial jobless claims remain low. Markets will be watching to see if we get the first negative number for payroll jobs since August 2003. While job growth has softened, wage inflation has yet to do so. Average hourly earnings rose a strong 0.4 percent December, matching the boost in November. The household survey in December pointed in the other direction — toward a softer labor market. The civilian unemployment rate rose to 5.0 percent from 4.7 percent in November. One thing is clear — the labor market data are very mixed and every facet of the employment report will be picked apart for more clarity on the direction of the economy.
Nonfarm payrolls Consensus Forecast for January 08: +58,000
Range: +25,000 to +120,000
Unemployment rate Consensus Forecast for January 08: 4.9 percent
Range: 4.9 to 5.0 percent
Average workweek Consensus Forecast for January 08: 33.8 hours
Range: 33.8 to 33.8 hours
Average hourly earnings Consensus Forecast for January 08: +0.3 percent
Range: +0.2 to +0.3 percent
The Institute for Supply Management’s manufacturing index has started to point to a possible decline in manufacturing as this composite index fell into negative territory with a reading of 47.7 in December, from 50.8 the month before. New orders were even weaker with a reading of 45.7 compared to 52.6 in November. Expectations are for another negative number in January. On a technical note, ISM starts using a new weighting methodology for the composite index with this release. Historical data are being revised.
ISM manufacturing index Consensus Forecast for January 08: 47.0
Range: 45.0 to 48.5
Construction spending in November unexpectedly rebounded slightly, led by nonresidential and public construction. Construction outlays rebounded 0.1 percent in November, following a 0.4 percent fall in October. November's gain in construction spending was led by a 2.5 percent jump in public outlays. Private nonresidential posted a 1.7 percent boost while private residential fell 2.5 percent. Expectations are for residential outlays to continue to fall while nonresidential may be softening. The nonresidential component has been keeping total outlays out of negative territory but that may be changing if nonresidential outlays are weakening. The Fed’s Beige Book recently has noted some softening in this sector.
Construction spending Consensus Forecast for December 07: -0.5 percent
Range: -0.8 to -0.2 percent
The Reuter’s/University of Michigan’s Consumer sentiment index reading for December firmed slightly from the preliminary reading, up 1 point to a still mild 75.5. Inflation expectations eased back 1 tenth for the one-year outlook to 3.4 percent. Five-year expectations are at 3.1 percent, unchanged from the preliminary reading but up 2 tenths compared with November. Consumer confidence data are soft, but personal spending data confirm that consumer spending is strong while inflation pressures are on the rise -- both tied to higher gas prices not necessarily to robust spirits.
Consumer sentiment Consensus Forecast for preliminary January 08: 79.0
Range: 75.0 to 80.5
Motor vehicle sales for domestics were flat in December, at a 12.1 million annual rate for domestic made which is one notch under November's 12.2 rate. Import sales were also flat. Auto sales are another key leading indicator for transition points in the economy. If vehicle sales hold up, a recession will likely be avoided. If they tank, the economy likely will follow.
Motor vehicle sales for domestics Consensus Forecast for January 08: 12.3 million-unit rate
Range: 11.8 to 12.6 million-unit rate
|
![[Econoday]](../../../../../../../../../images/logo.gif){kind=logo}
