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While the Fed was the focal point of the markets this past week, the fact that manufacturing may now be headed into recession got little attention. A variety of indicators found manufacturing in negative territory in February and March, adding to the fact that housing is severely depressed. A hope for some market participants is that the Fed’s aggressive cuts in interest rates – including this past week’s 75 basis point cut – and the Fed’s expansion of access to the discount window – will be kicking in soon enough to keep the economy from stalling further.
Volatility seems to be the operative word once again as stocks swung wildly during the past trading week, shorted by the Good Friday holiday. The Fed played key roles in the market swings but major indexes managed to pull off very respectable net gains for the week – the first weekly gain in a month.
 The start of the week was affected by the Fed’s surprise cut in the discount rate on Sunday along with the Fed’s creation of new lending facilities, and the Fed’s approval of a buyout of Bear Stearns by JP Morgan ended up spooking equities on concern that financials were overpriced. A sharp selloff in Asia and Europe also weighed on stocks even though the Dow did manage to eke out a small gain for the day. Many also chose to move money to safe refuges ahead of the Fed’s rate decision on Tuesday.
Equities soared on Tuesday as better-than-expected earnings from Lehman Brothers and Goldman Sachs put the markets in a good mood ahead of the FOMC announcement. Equities initially dipped just after the 2:15 ET announcement of a less-than-expected 75 basis point rate cut by the Fed. But in the last hour of trading, markets reevaluated and decided the Fed had made the right decision, especially taking into account the massive amounts of liquidity the Fed has already injected and is preparing to inject. The Dow ended the day up 420 points – the biggest surge in 5-1/2 years. Even so, the broader indexes posted even larger percentage gains than the Dow’s 3.5 percent gain with the S&P 500 up 4.2 percent, the Nasdaq up 4.2 percent, and the Russell 2000 up 4.8 percent.
But on Wednesday, stocks retreated sharply, giving up one-half or more of Tuesday’s surge. A variety of factors pushed equities down, with falling oil prices pulling down energy stocks and a decline in gold prices damped mining stocks. Financials were knocked down by CIT Group having its rating cut by Moody’s along with Discover announcing a drop in profits. Lehman Brother slipped on negative comments by an analyst regarding “troubled assets.” Plus there was just a lot simple profit taking after Tuesday jump in equities.
The markets headed into Thursday somewhat nervous due to the expiration of stock index futures and options and also individual stock futures and options (quadruple witching) as well as light trading heading into the three day weekend for traders. Stocks got a little boost from the Philly Fed index coming not quite as bad as expected as well as from favorable comments or upgrades from analysts for General Electric, Fannie Mae, and Freddie Mac with trading in a thin market.
Last week, major indexes were up as follows: the Dow, up 3.4 percent; the S&P 500, up 3.2 percent; the Nasdaq, up 2.1 percent; and the Russell 2000, up 2.8 percent.
Since year-end, major indexes are down as follows: the Dow, down 6.8 percent; the S&P 500, down 9.5 percent; the Nasdaq, down 14.9 percent; and the Russell 2000, down 11.0 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 mixed for the past week but the near end was sharply lower. Rates swung during the week with flight to quality, reversal of flight to quality, and Fed actions being the key factors behind the volatility.
Rates fell on Monday on flight to quality after the Fed’s Sunday discount rate cut and bailout of Bear Sterns boosted nervousness in the equity markets as well as in many non-Treasury segments of the credit markets. Strong bank earnings, the Fed’s 75 basis point rate cuts, and a surge in equities pushed rates back up on Tuesday with the 3-month T-bill being an exception. The T-bill was pulled lower by the Fed’s rate cut and by expectations of at least one more rate cut by the Fed.
Rates dipped on Wednesday on flight to quality over fears of a global slowing and as many traders parked funds in safe assets just before an extended three day weekend with some making it a four day weekend. Demand was heavy for the 3-month T-bill as investors bought the shortest maturities. The 3-month T-bill dropped 31 basis points for the day to close at 0.57 percent – its lowest level in 50 years. Funds also have moved somewhat from longer maturities due to increased margin calls for the increased volatility seen in some bonds. Rates ended the shortened week with news that CIT Group had to draw on a $7.3 billion line of credit after being unable to raise needed cash in debt markets which in turn kept funds in the near end Treasury bill.
 Treasury yields were mixed last week as follows: 3-month T-bill, down 54 basis points, the 2-year note, up 12 basis points; the 5-year note, down 2 basis points; the 10-year bond, down 11 basis points; and the 30-year bond, down 19 basis points.
The Fed’s slashing of the fed funds target rate and massive flight to safety ahead of the three day weekend pushed the 3-month T-bill to a 50 year low.
 Oil prices fell sharply this past week. Prices fell significantly in three of the four trading days. The Fed’s surprise discount rate cut on Sunday actually led to a drop in oil prices on fears of recession and some hedge fund managers in commodity-only funds were worried about exposure in the commodities markets. But on Tuesday, the Fed’s rate cut boosted prices over inflation concerns and a falling dollar. That reversed on Wednesday with a $4.94 plunge – the sharpest daily drop in 17 years. A surprise bump up in the dollar – due to the Fed’s cutting “only” 75 basis points instead of the expected 100 – pushed oil prices down along with the weekly oil inventories report that showed a drop in demand for gasoline. The report of weakened demand continued to weigh on prices Thursday due to increased worries over the impact of a slowing economy.
The spot price for West Texas Intermediate fell $7.42 per barrel net for the week to settle at $102.79 per barrel, down $7.42 from the record high of $110.21 set on March 14.
This past week the Fed took aggressive action to loosen up the credit markets with both an expansion of the discount window to investment houses and a huge cut in the fed funds target rate. Meanwhile, manufacturing has turned negative by a variety of measures and housing permits indicate a further decline in housing. Finally, the latest PPI data indicate that inflation is still entrenched, not yet responding to a soft economy and being boosted by commodity prices.
 The morning of the latest Fed rate cut, the PPI offered a reminder that inflation is still a problem and that we may be in for some moderate stagflation this year – weak economic growth combined with excessive inflation. Overall producer price inflation in February did moderate but not as much as needed given how sharp the prior month’s gain was – plus the moderation was due to a drop in energy costs that is not sustainable. The overall PPI rose 0.3 percent, following a 1.0 percent surge in January. However, the core rate is more clearly showing an uptrend in price presssures. The core rate inflation jumped to a 0.5 percent increase, following a 0.4 percent jump the month before.
 The year-on-year rate for the overall PPI stood at up 6.8 percent in January (seasonally adjusted) from up 7.7 percent in January. The year-on-year core rate increased to up 2.5 percent in February from up 2.4 percent in January. This is the highest rate for the core since 2.5 percent seen in September 2005.
The bottom line is that inflation is apparently somewhat more entrenched than the Fed had hoped. Part of the inflation problem is that the dollar has depreciated, making imported goods more expensive. Additionally, foreign economies are still robust, keeping prices under upward pressure.
 The latest housing starts report showed starts easing slightly but the more reliable permits data were much weaker, indicating that housing is showing no sign of bottoming. Starts fell back 0.6 percent to a 1.065 million unit annual rate, following a 7.1 percent surge in January, and left starts down 28.4 percent on a year-on-year rate. However, permits came in much weaker. While, starts can be affected by how seasonally typical the weather is, permits are less immune to vagaries in the weather. Building permits dropped 7.8 percent to a 0.978 million unit pace after declining 1.8 percent the month before, leaving the year-on-year rate a down 36.5 percent.
Within starts, weakness in the latest month was led by the single-family component which dropped 6.7 percent to an annualized 0.707 million unit pace. In contrast, multifamily starts rebounded 14.4 percent to a 0.299 million unit pace. Starts are going to remain depressed – at least for the single-family component – until unsold inventories of new and existing homes on the market are worked down.
 The manufacturing sector helped to keep the economy out of recession throughout 2007 with its robust growth. But recently, the health of this sector has come into question as new orders have slipped and now production has turned soft for several months – including a decline for the latest month. In February, overall industrial production dropped 0.5 percent, following a 0.1 percent gain the month before. The manufacturing component declined 0.2 percent in the latest month while utilities output dropped 3.7 percent and mining output rose 0.4 percent.
Two key sources of demand for manufacturing are behind the recent decline in manufacturing – the depressed housing sector and a recent pullback by the consumer – notably for motor vehicles. Output for consumer goods fell 0.6 percent in February with automotive products down 1.3 percent and appliances, furniture & carpeting falling 3.1 percent. Construction supplies fell significantly while output of defense & space equipment retraced part of a surge in January. A mild positive for the latest month was a 0.1 percent boost in output of business equipment.
Typically, a decline in interest rates will boost both auto sales and home sales. This time, however, the current credit crunch, a likely overextended consumer, and a massive build up in inventories of unsold homes on the market will likely mitigate the usual strong rebound in housing and in autos that would spur manufacturing. The positive for manufacturing remains the weak dollar which is boosting exports.
Overall capacity utilization declined to 80.9 percent in February from 81.3 percent the prior month and compared to the market projection of 81.3 percent.
 More evidence of a possible recession in manufacturing came from the latest Empire State manufacturing survey. The New York Fed’s manufacturing index fell to minus 22.2 in March from minus 11.7 in February. March’s level set a new historical low for the series, eclipsing the previous low of minus 22.2 set in November 2001. The new orders index remained in negative territory, coming in at minus 4.7, compared to minus 11.9 the previous month. On the positive side, unfilled orders were stable and the six-month outlook was strong. But if new orders continue soft, then the overall outlook could also turn negative.
Pressures on input costs, however and unfortunately, are severe with prices paid up more than 3 points to 50.6. But only some of this pressure is feeding through to final prices as prices received came in at 15.7, down about 2 points in what could be considered a mild positive for the inflation outlook but a negative for manufacturers’ profits.
The latest indication that manufacturing is already in a contraction was this past week’s release of the Philly Fed index which was negative for a fourth month in a row, coming in at minus 17.4 in March after minus 24.0 in February. There's little solace in the improvement as the negative reading nevertheless indicates month-to-month contraction as more respondents continue to report slowing than growth. New orders, arguably the most important reading in the report, was not as severe but is still pointing downward at minus 9.3 following minus 10.9 the month before. Inventories and unfilled orders are declining and delivery times are quickening, all reflecting the slowdown in production. Employment is also being cut back.
 Unfortunately, prices are not showing signs of slowing and even are worsening on the input side. The priced paid index jumped to 54.4 from 46.6 in February. On the output side, prices received remained elevated at 21.1 versus 24.3 in February.
The outlook for manufacturing does not look positive for the near term as the overall six-month outlook index, which is usually upbeat, remained negative at -0.5. Manufacturing in the Mid-Atlantic region clearly has been in recession for a few months and the rest of U.S. manufacturing may be close behind.
The Conference Board’s index of leading indicators is pointing in the direction of recession with a 0.3 percent decline that followed drops of 0.4 percent in January and 0.1 percent in December. The latest was the fifth in a row – the longest losing streak since 2001. What may be a surprise to many is that the coincident index does not yet indicate we are in recession. The coincident index is heavily considered by the National Bureau of Economic Research when marking the start of recession. This index was flat in February, following no change the previous two months. However, this is as close as you can get to recession and not be in recession for the overall economy – and the numbers can be revised, including downward.
This past week Fed seemed almost to be putting on an old fashioned magic act in which the performer continues to pull one rabbit after another out of the hat – and when you least expect it. The business week started early with a rare Sunday cut in the discount rate and with an announcement of an extension of the discount window to investment houses. On Tuesday, the Fed’s once again sharp rate cuts had the Fed trying to work its magic on the economy.
The Fed has pulled quite a few rabbits out of it hat in recent months, including, a surprise discount rate cut in August, the creation Term Auction Facility to add liquidity by auctioning reserves, an emergency rate cut of 75 basis points on January 22, the creation of Term Securities Lending Facility to extend discount window rights to primary dealers and expand types of collateral accepted (including some mortgage back securities). The first rabbit out of the Fed’s hat last week came very early in the week. On Sunday, March 16, in unusually timed moves and a mere two days before its policy meeting, the Federal Reserve Board made two surprise moves to improve credit conditions – the Fed cut the discount rate and created a new credit facility for primary dealers. The Federal Reserve Board unanimously approved a request by the Federal Reserve Bank of New York to decrease the primary credit rate from 3-1/2 percent to 3-1/4 percent. This step lowered the spread of the primary credit rate over the Federal Open Market Committee's target federal funds rate to 1/4 percentage point and makes going to the discount window more attractive. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days. The cut in the discount rate and the extension of the maximum maturity of discount window loans were intended to improve liquidity in the credit market.
The second rabbit out of the hat this past Sunday was that the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. Primary dealers are select banks and securities broker-dealers with whom the New York conducts open market operations by trading U.S. government and select other securities. Currently, there are 20 primary dealers. The new facility, called the Federal Reserve Primary Dealer Credit Facility ("PDCF"), opened for business on Monday, March 17 and will be in place for at least six months and may be extended as conditions warrant. This new facility is for overnight loans for primary dealers. The bottom line is that with this new facility in place, there is no reason for investors to believe that a healthy financial firm can be forced to close “merely” due to a cash run on the firm – overnight loans are readily available from the Fed. Additionally, the Fed is now allowing a broader range of collateral for this facility – including all collateral eligible for pledge in open market operations, plus investment grade corporate securities, municipal securities, mortgage-backed securities, and asset-backed securities. One last “rabbit” – the Fed announced an expansion of this collateral mid-afternoon Friday and added agency collateralized-mortgage obligations (CMOs) and AAA/Aaa-rated commercial mortgage-backed securities (CMBS). This overall expansion of acceptable collateral will free up a lot of previously illiquid assets and help to ease the credit crisis.
 Sometimes a good magician gives the audience something unexpected and that is what the Fed did with its latest policy move. The FOMC surprised the financial markets by actually not giving them everything they wanted and cut the fed funds rate target and discount rate by 75 basis points instead of the expected 100 basis points. The fed funds target rate is now 2.25 percent and the discount rate is now 2.50 percent. The vote was not unanimous – Dallas Fed President Richard Fischer and Philadelphia Fed President Charles Plosser dissented, preferring less aggressive easing.
The FOMC indicated that downside risks to the economy remain and implicitly is keeping options open for further rate cuts. However, the meeting statement implied that recent measures to improve liquidity in credit markets is likely a key reason that the Fed did not cut as much as expected. "Today's policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity."
 The other reason the Fed may not have been as aggressive is a concern that inflation is still a problem. The statement gave considerable attention to the problem that inflation has not come down as the Fed had hoped. "Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."
Indeed, the trend for inflation has not been good. According to the latest numbers for the Fed’s preferred inflation measures – PCE price indexes – overall consumer price inflation is at a strong 3.7 percent year-on-year pace while core PCE inflation has risen to a 2.2 percent rate. According to the Fed’s medium-term inflation forecasts, the Fed’s implied inflation target is 1-1/2 to 2 percent PCE price inflation – a range current numbers are well above. The Fed clearly is still hoping that economic weakness will pull inflation down – or the Fed will need to reverse recent rate cuts not far down the road. Inflation concerns mean that the Fed may have very few rabbits left to pull out of its hat.
Softness in the economy is spreading despite the Fed’s rate cuts with housing continuing to spiral downward and now with manufacturing possibly already in a downtrend. The good news is that the full impact of Fed rate cuts has not yet been felt and should be boosting the economy in coming months.
The week ahead for market moving indicators has the durable goods report giving us an update on manufacturing; GDP is revised for the final time for the fourth quarter; and the personal income report gives us insight on whether the consumer is losing steam or not. Second tier indicators include the currently important housing numbers for both existing and new home sales as well as both national reports on consumer confidence.
Existing home sales continued to spiral downward in January, showing no sign of leveling off. Existing home sales slipped 0.4 percent in January for a 23.4 percent year-on-year decline that's the worst on record. Supply was the really bad news in the report, which ballooned to 10.3 months from 9.7 months in December. The median price fell 2.9 percent in the month to $201,100 for a year-on-year decline of 4.6 percent.
Existing home sales Consensus Forecast for February 08: 4.85 million-unit rate
Range: 4.79 to 4.90 million-unit rate
The Conference Board's consumer confidence index continued downward, reflecting concern over rising gasoline prices, stock market declines, and consumer balance sheets – not to mention the publicly bantered credit market concerns. The index slipped badly in February to 75.0 from 87.3 in January. The latest reading is the lowest since the beginning of the expansion in early 2003. Pessimists have overtaken optimists in four the report's five main components with future income the only positive. The only good news in the report was a steady reading in one year inflation expectations, unchanged at 5.3 percent and in contrast to a mid-month spike in the Reuters/University of Michigan reading.
Consumer confidence Consensus Forecast for March 08: 73.0
Range: 71.0 to 78.0
Durable goods orders now have been pointing to a decline in the manufacturing sector and possibly the economy overall. Durable goods orders retreated 5.3 percent in January, following a 4.4 percent surge in December. Excluding the transportation component, new orders still came in weak, falling 1.6 percent in January, following a 2.0 percent boost in December. While a large portion of January's weakness was in aircraft orders, declines were fairly widespread. There still is some forward momentum in orders backlogs but if new orders do not pick up, then manufacturing will help pull the overall economy into recession.
New orders for durable goods Consensus Forecast for February 08: +0.7 percent
Range: -0.5 percent to +3.0 percent
New home sales are key for helping clear the pileup in unsold inventories but a rebound is still yet to happen as sales continue their plunge, down 2.8 percent in January to a 588,000 annual rate for a year-on-year decline of 34 percent. The 588,000 rate is among the very the lowest since the 1991 recession. Prices now appear to be coming apart, dropping 4.3 percent in January alone following a 9.3 percent plunge in December. The year-on-year decline is at 15.1 percent -- this is a record for the series which goes back to the early 60s. Supply is swollen, at 9.9 months and the highest of this housing slump and the worst since the recessions in 1991 and the early 1980s.
New home sales Consensus Forecast for February 08: 575 thousand-unit annual rate
Range: 570 thousand to 610 thousand-unit annual rate
Real GDP for the fourth quarter was left unrevised in the first revision at an annualized 0.6 percent and followed a robust 4.9 annualized increase in the third quarter. Normally, a final revision to a quarter is not of much interest but the quarter was so weak that it is still possible that there could be enough of a downward revision to give us a negative quarter. The data are old news and there is not much difference in reality between an incremental rise and an incremental decrease but the final revision could make a difference in terms of whether some view a recession as having begun late last year. The fourth quarter GDP price index came in at 2.7 percent.
Real GDP Consensus Forecast for final Q4 08: 0.6 percent annual rate
Range: +0.5 to +0.9 percent annual rate
GDP price index Consensus Forecast for final Q4 08: +2.7 percent annual rate
Range: +2.7 to +2.7 percent annual rate
Initial jobless claims spiked higher in the week ending March 15 week with initial claims jumping 22,000 to 378,000. Some of the latest increase is due to an ongoing strike at American Axle which has shut down production plants at General Motors. But weakness is evident with continuing claims confirming trouble, up 32,000 in the week ending March 8 to 2.865 million. The latest initial claims numbers fall on the same week as the surveys for the monthly jobs report and point to another disappointing employment report for March.
Jobless Claims Consensus Forecast for 3/22/08: 370,000
Range: 360,000 to 385,000
Personal income growth has been strong enough to fuel consumer spending and despite a dip in employment, we may still get moderately healthy income growth for February. Personal income in January slowed to a 0.3 percent gain, following a 0.5 percent increase the month before. As part of the negative February employment report, aggregate earnings of production and nonsupervisory workers actually rebounded 0.3 percent for the month after a very small dip (less than one-tenth of a percent) in January. This was largely due to a 0.3 percent boost in average hourly earnings. However, inflation worsened in January as the overall PCE price index increased 0.4 percent, following a 0.3 percent boost in December. Even the core PCE price index firmed with a 0.3 percent gain in January after a 0.2 percent rise the month before. Based on a flat numbers for both the headline CPI and core CPI for February, we are likely to see some improvement in both PCE index measures – even if only temporarily.
Personal income Consensus Forecast for February 08: +0.3 percent
Range: 0.0 to +0.4 percent
Personal consumption expenditures Consensus Forecast for February 08: +0.1 percent
Range: -0.1 to +0.2 percent
Core PCE price index Consensus Forecast for February 08: +0.2 percent
Range: -0.2 to +0.3 percent
The Reuter’s/University of Michigan’s Consumer sentiment index was little changed in the mid-month reading for March with a very weak 70.5 versus 70.8 for February. Most importantly, one-year inflation expectations, in contrast to February's surprisingly soft CPI numbers, jumped 9 tenths to 4.5 percent, an extremely sudden and steep jump to a very elevated level. One mild offset is that 5-year inflation expectations slipped 1 tenth to 2.9 percent. The Fed needs consumer confidence to hold up, otherwise the risk of recession rises. At the same time, the Fed will be closely watching the inflation expectations numbers to see if expectations are staying “anchored” – a key issue in the Fed’s monetary policy deliberations.
Consumer sentiment Consensus Forecast for final March 08: 70.0
Range: 69.5 to 71.0
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