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Last week we got a sobering surprise of a drop in consumer spending in February. The all important consumer sector may no longer keep the economy from being pulled into recession by depressed housing and slowing manufacturing. Yet while a slowing in the consumer sector is a key story, the other big story is Fed related. The Fed got more deeply involved in propping up the credit markets by extending credit to primary dealers and by indirectly extending credit to a key investment house, Bear Stearns. And by Friday, market participants were glad to just head home and start mulling over their positions before this Tuesday’s pending rate decision by the Fed.
Equities took a wild ride last week and ended up mixed for the week. Even though there were some important economic indicators out, equity swings were largely on news from the Fed or the credit markets. Markets started the week in a somber mood, still reflecting on the prior Friday’s negative jobs report. Rumors that large investment banks would be announcing additional large writedowns pushed financials and the broad market down. Bear Stearns in particular was the target of rumors of a cash crunch problem for the investment house.
But stocks got their biggest lift in years after the Fed announced that it would lend $200 billion to banks by extending special auctions to primary dealers and other measures. The Dow jumped 3.5 percent – its biggest gain since March 2003. The Fed’s move to extend auction rights to primary dealers was seen as dramatically improving liquidity in the credit markets. Stocks dipped on Wednesday on profit taking and over concern that record high oil prices could dampen economic growth. A drop in retail sales initially weighed on stocks on Thursday along with news that Carlyle Capital could not meet margin calls but a report by S&P’s rating division indicated that banks had already disclosed half of the expected write-offs for bad loans. In contrast, a very favorable CPI report on Friday gave stocks an initial boost in the morning but equities fell sharply on news that investment house Bear Stearns was forced to arrange a cash infusion through JP Morgan going to the New York Fed’s discount window on behalf of Bear Sterns. The Fed Board approved the arrangement for an undisclosed amount to be loaned over a 28 day period, relying on a Depression era law that allows the Fed to lend to nonbanks. The news raised fears in the markets of further cash crunches in other financial firms and that credit market problems were a long way from being solved.
Last week, major indexes were mixed as follows: the Dow, up 0.5 percent; the S&P 500, down 0.4 percent; the Nasdaq, unchanged net; and the Russell 2000, up 0.4 percent.
Since year-end, major indexes are down as follows: the Dow, down 9.9 percent; the S&P 500, down 12.3 percent; the Nasdaq, down 16.6 percent; and the Russell 2000, down 13.5 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury yields were down last week across the yield curve but notably on the near end. Weighing on yields were flight to quality and new expectations that the Fed might actually cut the fed funds target rate by 100 basis points on March 18.
Rates dipped right out of the gate last week as recession fears were at the forefront with the negative jobs report still fresh in traders’ memories. The Fed’s news of an expanded auction to primary dealers pumped up equities with funds flowing out of Treasuries, nudging rates up. But on Wednesday, an unexpected fall in retail sales and credit market concerns boosted prices and eased rates. That reversed on Thursday as a weak auction for 10-year Treasuries bumped rates back up on Thursday. Rates ended the week by dropping notably on Friday due to flight to quality over Bear Sterns’ cash crunch caused by investors pulling their funds out and the need for the Fed and JP Morgan to come to Bear Stearns’ rescue. Such a dramatic move raised fears of more of the same to come. The 3-month T-bill rate came under heavy pressure as Friday’s events led many to believe that the Fed would not settle for a 75 basis point cut in the fed funds target rate but would go for a full percentage point drop.
 Treasury yields were down last week as follows: 3-month T-bill, down 29 basis points, the 2-year note; down 5 basis points; the 5-year note, down 4 basis points; the 10-year bond, down 11 basis points; and the 30-year bond, down 20 basis points.
Growing expectations of even larger rate cuts by the Fed pulled the near end of the yield curve down sharply as the maturity dates of those instruments fall after expected Fed rate cuts.
 It just does not seem to end – crude oil prices continued to set new record highs last week with records set in four of the five trading days. The big jump was on Monday as the spot price for West Texas Intermediate rose $2.38 a barrel to $107.90. A strong wholesale report boosted prices but the key factor was that oil appeared to be a more attractive investment than many alternatives – notably stocks. Prices continued to rise Tuesday and Wednesday with Wednesday’s gain occurring despite a rise in crude stocks. Prices were led upward largely on speculation. Prices dipped on Thursday on fears of softening demand. But the week ended on an upswing and a new record settlement at $110.21 per barrel. Record lows in the dollar helped crude reach its new high. The weaker dollar had been providing support for oil throughout the week as it has for some time.
The spot price for West Texas Intermediate jumped $4.69 per barrel net for the week to settle at a new record close of $110.21 per barrel.
Outside of exports, the economy continued to weaken with the consumer sector turning negative in key reports. Inflation, however, improved – even though probably only temporarily.
 The consumer does the heavy lifting in the U.S. economy and whether the economy contracts or not depends very much on the consumer sector. The consumer sector makes up about two-thirds of the economy. While housing has been in a tailspin throughout last year, the consumer held up quite well – but that may be changing. Retail sales unexpectedly dropped in February and indicate that the consumer sector is under a lot more stress than previously believed and no longer can keep the economy out of a downturn. Retail sales fell 0.6 percent in February, following a 0.4 percent gain the month before. Excluding motor vehicles, retail sales declined 0.2 percent after rebounding 0.5 percent in January. When excluding both motor vehicles and gasoline, sales were also lower, down 0.1 percent in the latest month after rising 0.2 percent in January.
By components, February's decline was led by motor vehicle sales and gasoline. But what is somewhat disconcerting is that weakness has spread to some unexpected areas. Electronics fell and spending was weak in staple goods with food & beverage store sales dropping. Decreases were also seen in furniture, building materials & garden equipment, miscellaneous store retailers, and food services & drinking places. Gains were seen in sporting goods, general merchandise, and apparel. The bottom line is that if the consumer sector weakens further, the economy will clearly be in recession.
 A slowing in the consumer sector was also seen in the February CPI report as weak demand helped ease some components. Consumer prices in February shocked the markets on the downside with both the headline number and core CPI coming in at unchanged.
What pulled February so low? Helping to ease core inflation were apparel, down 0.3 percent, and new & used motor vehicles, down 0.2 percent. Weaker demand appears to have help soften these components. Also, medical care was very soft with a 0.1 percent rise but this was largely just an offset to the sharp 0.5 percent surge in January. Helping to flatten the headline number was a 0.5 percent drop in energy costs, led by a 2.0 percent drop in motor fuel and a 1.2 percent fall in heating oil.
While many point to the latst CPI as indicating that inflation is under control, the better view is probably that the last two months have been aberrations somewhat with January overstating inflation and February understating. January had been notably strong with headline and core numbers coming in at 0.4 percent and 0.3 percent, respectively. Trend inflation is likely in between the two months.
 Year-on-year, the overall CPI eased to up 4.1 percent in February from up 4.4 percent in January. The core rate was slipped to up 2.3 percent from up 2.5 percent the prior month.
Indeed, the Fed will not likely be too optimistic about February’s numbers reflecting the true inflation trend – although they do provide a fig leaf for the Fed to ease sharply on March 18. But looking ahead, it is highly unlikely that we will get a repeat of the flat readings for the March CPI – oil prices have spiked sharply, commodity prices have risen, and import prices continue to rise.
 Despite a more moderate gain in February, import prices remain under significant upward pressure. Overall import prices rose 0.2 percent in February from a 1.6 percent spike the month before. But this easing was due to a temporary 1.5 percent drop in petroleum import prices. Outside of petroleum, prices were strong as non-petroleum showed a steep 0.6 percent rise which followed a 0.7 percent boost in January. Gains were led by nonpetroleum industrial supplies by by metals.
Not only were commodities showing price pressure but imported consumer goods prices remained strong with a 0.3 percent increase after a 0.5 percent jump in January. The bottom line is that due to a lower dollar and strong demand overseas for commodities, import prices remain on a strong uptrend. Year-on-year, import prices are up 13.6 percent, right at January's rate for the worst readings in more than 25 years of data.
 While housing has been in depression and the consumer sector now appears to be slowing, the big bright spot in the economy is still the trade sector. While the overall U.S. trade gap was nudged up by higher oil prices to $58.2 billion from $57.9 billion gap in December, the underlying trend is still favorable. Importantly, the nonoil trade gap shrank notably, helped not just by higher exports but also by lower nonoil imports. The nonoil trade gap slipped to $32.1 billion in January from $34.8 billion the month before.
Exports rose by a healthy 1.6 percent in January, putting year-on-year growth at 16.6 percent. Imports rose 1.3 percent for the latest month, putting the year-ago rate at 11.9 percent. But in another sign of a slowing consumer sector, consumer goods imports fell a sharp 4.3 percent in January after declining 1.2 percent the month before. Capital goods imports also weakened in January. The bottom line is that exports are still boosting U.S. growth and while lower imports help the trade balance, the lower import of consumer goods is a warning flag of poor health in the consumer sector.
The economy has grown softer with the bulwark consumer sector now suspect. Growth clearly is flat and possibly negative. But the key problem still appears to be the credit markets due to illiquidity and the related problem of still looming losses by banks and other financial firms. The Fed is using as many weapons as possible to support the credit markets and bolster the economy. The Fed is now having to weigh whether additional rate cuts will really help that much – although Fed Chairman Ben Bernanke stated last week that lower rates are mitigating adjustable mortgage loan resets and that may be the only real reason the Fed is still cutting rates. The fed funds futures market is now betting a 100 percent probability of at least a 75 basis point cut in the fed funds target rate on March 18 and over a 50 percent chance of a 100 basis point cut. Regardless of the size of the rate cut, the big question is whether the Fed choice will boost market confidence – especially in the credit markets – or will the rate decision spook the markets. We will find out this Tuesday at 2:15 p.m. ET.
 The Fed funds futures market has the fed funds target rate down to 1-1/2 percent by August of this year. However, this market also expects the Fed to start tightening again during the first half of 2009 but the odds currently are moderate for only a slight increase.
The week ahead is shortened by the Good Friday holiday on Friday. For market moving indicators, the highlight will be the FOMC announcement on Tuesday afternoon. But setting the table ahead will be industrial production on Monday and the key housing starts report and producer prices on Tuesday morning. The Fed will have seen some heavy duty indicators from last week and early this week prior to its expected cut in the fed funds target rate on Tuesday afternoon.
The Empire State manufacturing index has been soft since November but actually fell into negative territory in February at minus 11.7. We may get another negative in March as February’s weakness was centered in new orders, at minus 11.9. However, oil and other commodities are keeping prices high as prices paid jumped more than 7 points in February to 47.4 and prices received were little changed at 17.9.
Empire State Manufacturing Survey Consensus Forecast for March 08: -6.3
Range: -13.0 to -5.0
Industrial production has slowed significantly and has barely stayed in positive territory, rising a meager up 0.1 percent in January, matching December's rise. But the positives were in utilities and mining as the manufacturing component was flat in January. Overall capacity utilization was unchanged at 81.5 percent. Looking ahead, industrial production is likely to post a decline as suggested by the February jobs report which showed a 0.5 percent fall in aggregate production hours in manufacturing.
Industrial production Consensus Forecast for February: -0.1 percent
Range: -0.6 to +0.2 percent
Capacity utilization Consensus Forecast for February 08: 81.3 percent
Range: 80.3 to 81.5 percent
Housing starts paused in its downward spiral with a modest 0.8 percent rise in January. Still, the latest number for a 1.012 million unit pace is still badly depressed and is down 28 percent on a year-on-year basis. Given the continued high levels of unsold new and existing homes, starts are likely to resume their downtrend in February.
Housing starts Consensus Forecast for February 08: 0.99 million-unit rate
Range: 0.96 million to 1.02 million-unit rate
The producer price index was red hot in January with a monthly 1.0 percent surge with the core rate increasing to 0.4 percent. More recent data have been mixed. We got an unusually early release for the CPI and it came in very tame for February. In contrast, commodities prices continue to be robust and the PPI is more sensitive to commodities than the services-laden CPI. One oddity to some about the February CPI number was the decline in energy costs. This was likely due to seasonal adjustment expectations versus still high unadjusted energy prices. We may see a similar effect on the PPI energy components which could soften the PPI for February.
PPI Consensus Forecast for February 08: +0.4 percent
Range: -0.1 to +1.0 percent
PPI ex food & energy Consensus Forecast for February 08: +0.2 percent
Range: +0.1 to +0.3 percent
The FOMC announcement for the March 18 FOMC policy meeting is expected to cut the fed funds rate sharply by 100 basis points with the markets moving to this extreme belief after this past Friday’s Fed/JP Morgan rescue of Bear Stearns. The fed funds futures market has the odds just over 50 percent for a 100 basis point cut with a 100 percent probability priced in for at least a 75 basis point cut. Nonetheless, the Fed has a lot to mull over in terms of how to best stabilize the credit markets and stave off recession. Economic data have been weak but last week’s intervention for Bear Stearns appeared to have unnerved the markets. So, whether the Fed goes for 75 or 100 basis points, the question remains whether the move helps to soothe the markets.
FOMC Consensus Forecast for 3/18/08 policy vote on fed funds target: down 100 basis points to 2 percent
Range: 52 percent probability for 100 basis point cut and 48 percent probability for 75 basis point cut based on fed funds futures settle for March 14, 2008
Initial jobless claims are still on the high side but at least are holding somewhat steady and not worsening. Initial claims were unchanged in the week ending March 8 at 353,000, a bit better than the four-week average of 358,500 but still indicating soft conditions in the labor market. Continuing claims were also little changed, up 7,000 to 2.835 million that also indicates softness.
Jobless Claims Consensus Forecast for 3/15/08: 360,000
Range: 345,000 to 370,000
The general business conditions component of the Philadelphia Fed's business outlook survey index has been showing the scariest numbers for the manufacturing sector, plunging to minus 24.0 in February. March is likely to stay in negative territory as new orders contracted for a second month, coming in at minus 10.9, following a minus 15.2 reading in January. Nonetheless, price pressure remains high as February prices paid stood at 46.6 while prices received was 24.3.
Philadelphia Fed survey Consensus Forecast for March 08: -20.0
Range: -20.2 to -5.2
The Conference Board's index of leading indicators slipped 0.1 percent in January, reflecting declines in stock prices, capital goods orders, and building permits. While this index is getting a little more attention than usual, many forget to read the whole report which also includes the index of coincident indicators. While not completely definitive, the coincident index carries a lot of weight when the start or end of recession is defined – that is, when is there a new string of negative numbers or a new string of positive numbers? As of January, the coincident index was still positive with a 0.1 percent increase.
Leading indicators Consensus Forecast for February 08: -0.3 percent
Range: -0.6 to 0.0 percent
Good Friday holiday. Markets closed. Banks open.
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