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With the third consecutive drop in payroll jobs in the March employment report, there can be no doubt that the U.S. economy is in a contraction, albeit a very mild one at this point. However, it remains to be seen whether the slippage will become a full-fledged recession. Despite the gloomy news on the labor market, equities got off to quite a good start for the second quarter, setting aside the fact that the first quarter had been abysmal.
 Indeed, equities got the second quarter off to a good start despite what should have been notable headwinds from negative economic data. Monday saw modest gains overall, largely due to declining oil prices, end of quarter window dressing, and on Treasury Secretary Paulson’s announcement of proposed financial system reform. The big negatives were for drug makers Merck and Schering-Plough which saw a drop in value on research reports that found their joint cholesterol treatment Vytorin to be no more effective than alternative, cheaper drugs.
The big spike in stocks was on Tuesday with major indexes up from 3 to 3-1/2 percent for the day. The big lift under stocks came from announcements by key financial firms, Lehman Brothers and UBS, that they were raising billions in additional capital, soothing markets that these big players would be able to withstand potential stress. Financials led the way for a strong, broad-based rally. Gainers included the likes of Lehman, UBS, Fannie Mae, Citigroup, Morgan Stanley, and even Thornborg Mortgage. Also supporting gains was an ISM report on manufacturing which was not as weak as feared. Markets were mixed on Wednesday and Thursday on relief that no new shoes dropped during congressional testimony on the Fed’s assistance in JPMorgan’s takeover of Bear Stearns. Markets edged up during most of the last day of the week despite a strong-than-expected decline in payroll jobs in March as traders increasingly came to believe that the worst is over for equities – a belief that could easily change with earnings season on deck. But stocks ended mixed for the day with the Dow down marginally and other indexes barely positive.
A curiosity about this past week’s stock returns and economic data is that equities were up substantially net for the week even though all of the key economic data were either negative or flat. With the notable exception of payroll employment, data mostly came in not as bad as expected, partially explaining the quandary.
Last week, the techs and small caps led gains in equities. Major indexes up substantially as follows: the Dow, up 32 percent; the S&P 500, up 4.2 percent; the Nasdaq, up 4.9 percent; and the Russell 2000, up 4.5 percent.
 Despite some modest window dressing based gains on the last day of the quarter, equity indexes in the first quarter posted the largest quarterly losses since 2002. Major indexes were down as follows: the Dow, down 7.6 percent; the S&P 500, down 9.9 percent; the Nasdaq, down 14.1 percent; and the Russell 2000, down 10.2 percent. The worst portion of the quarterly declines was during the first three weeks of January.
 For the latest month, major indexes mixed as follows: the Dow, down fractionally but essentially unchanged; the S&P 500, down 0.6 percent; the Nasdaq, up 0.3 percent; and the Russell 2000, up 0.3 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 little changed except for notes yields which were up moderately.
The past week started with flight to quality as rates dipped modestly on Monday after Treasury Secretary Paulson’s announcement of proposed reform of the financial system. Markets were skeptical that the proposal would help the current credit crisis. Rates generally rose by double digit basis points on Tuesday as funds flowed out of Treasuries and into stocks with the big rally in equities. On Wednesday, Fed Chairman Bernanke’s testimony before Congress led markets to lower their expectations for further rate cuts, nudging most rates up for the day. Rates were little changed on Thursday as markets were relieved that congressional testimony on the buyout of Bear Stearns by JPMorgan provided no new revelations of any similar pending bankruptcies of financial firms. Friday’s weaker-than-expected jobs report helped rates ease moderately on the final day of the week.
 Treasury yields were mixed last week as follows: 3-month T-bill, unchanged, the 2-year note, up 16 basis points; the 5-year note, up 10 basis points; the 10-year bond, up 2 basis points; and the 30-year bond, down 2 basis points.
The yield curve was little changed this past week except for a mild bump up in 2-year and 5-year rates but the 3-month T-bill yield remains very low on continued expectations of further Fed rate cuts and continuing credit market concerns.
 Last week, oil prices were little changed despite some intraweek volatility. Spot prices for West Texas Intermediate dropped over $4 per barrel on Monday as the quarter closed and heating oil contracts were expiring, leaving many traders to unwind some of those trades. After little change on Tuesday, prices jumped just under $4 per barrel on a government report that gasoline supplies had dropped sharply, indicating a greater need for crude to refine. Prices dipped modestly on Thursday over recession fears but were bumped back up on Friday on a decline in the dollar.
The spot price for West Texas Intermediate rose $0.63 per barrel net for the week to settle at $106.23 per barrel, down $3.98 from the record high of $110.21 set on March 14.
This past week, the March employment report was the highlight – or rather lowlight – of the week with a third consecutive drop in payroll employment and a jump in unemployment. A number of key surveys also show both the manufacturing and non-manufacturing sectors to either be contracting slightly or to be flat. Unfortunately, all of the inflation readings were elevated last week.
 The big news out of the March employment report was not just a third consecutive decline but that labor market weakness clearly has spread to the service sector. The bottom line for the economy is that this represents a clear weakening in the consumer sector – the consumer is responsible for two thirds of the economy and the decline in jobs puts consumer spending at risk. Nonfarm payroll employment in March fell for the third month in a row, declining 80,000, following a decrease of 76,000 for February and a decrease also of 76,000 in January. The latest decline was led by construction, manufacturing, and professional & business services. March’s fall in payroll jobs was the worst since a 212,000 decrease for March 2003.
 Payroll weakness was led by the goods-producing sectors again but softness has spread to services. Construction jobs fell by 51,000 in March while manufacturing employment fell 48,000. But the service-providing sector has been flat for the last three months. Service-providing jobs rose a mere 13,000 in March, following a 6,000 rebound in February after declining 7,000 in January. In the latest month, weakness was led by declines in professional & business services and trade & transportation.
 But the Fed is not yet getting much of a reprieve on the inflation front from the labor sector. Average hourly earnings increased 0.3 percent in March – the same as the prior month. On a year-on-year basis, wages are still a little firm at a 3.6 percent pace, down from 3.7 percent the month before. The latest number is down from the cycle peak of 4.3 percent set in December 2006 but well above the cycle low of 1.6 percent for February 2004.
Turning to the household survey, the civilian unemployment rate worsened to 5.1 percent from 4.8 percent in February. March’s unemployment rate is the highest since 5.1 percent for September 2005. The latest number is well below the last peak at 6.3 percent in June 2003.
The March jobs report shows the labor markets softness spreading to the services sector – a clear indication that the overall economy is dipping into negative territory. The bottom line is that the consumer sector had been holding up well enough to keep the economy out of recession but that no longer seems to be the case. With unemployment rising and jobs falling, the consumer is going to grow more cautious and economic growth is going to be flat to negative for a while – at least until help comes from tax rebate checks and lagged effects from lower interest rates.
On an incidental note, the downward revisions to January and February payroll numbers will likely lead to downward revisions in the Conference Board’s index of coincident indicators for those months and push the index into negative numbers. This index carries a lot of weight in determining when recessions start and if the latest trend in jobs continues, then a recession likely started in January – barring downward annual revisions to other months.
 Not only is the latest employment report pointing toward contraction in manufacturing but so are a number of manufacturing surveys with the latest being the ISM index. The March ISM index which came in at a sub-50 level of 48.6, up 3 tenths from February but still indicating month-to-month contraction. The index has now come in below 50 in three of the last four reports, the worst performance since the beginning of the expansion in 2003. Unfortunately, new orders are suggesting continued weakness ahead, coming in at 46.5, down more than 2-1/2 points. On the positive side, new export orders rose slightly to 56.5.
The worst news in the report are prices paid which jumped 8 points to 83.5 for its worst reading in nearly four years. Whether these pressures begin bleeding through to final goods is one of the biggest risks facing the economy. In either event, the near-term outcome is not good – either profit margins are squeezed or inflation is passed along.
 Curiously, one of the notable pieces of good news this past week was essentially a flat number – another indication that the economy is under the weather. The March ISM non-manufacturing composite index was little changed, nudging up 3 tenths from February to 49.6 – basically right at the break-even point. New orders also ended up at the flat mark, rising 6 tenths to 50.2. As with the ISM manufacturing report, the big negative was a increase in the prices paid index by nearly 3 points to 70.8. But price pressures are not showing up on the demand side for non-manufacturers as supplier deliveries remained soft, indicating no notable shortages.
 The latest regional survey – the Chicago purchasers report – showed a gain in its overall index but it was still a sub-50 reading, indicating more firms reported contraction than those reporting gains. In March, the headline index gained nearly 4 points but fell short of the break-even mark of 50, coming in at 48.2. But this survey is a little more optimistic about the outlook than other surveys as the new orders index advanced more than 5 points to 53.9. Once again, the worst news is another rise in prices paid, up 4.5 points to 83.9 and reflecting high fuel costs and also high costs for other raw materials including steel.
 Construction continues to pull the economy down with both residential and nonresidential construction outlays falling in the latest month. Construction spending in February continued downward, posting a 0.3 percent drop, following a 1.0 percent fall in January. February's decrease in construction spending was led by a 0.9 percent decline in private residential outlays with private nonresidential construction slipping 0.1 percent. However, public outlays advanced 0.4 percent in the latest month. On a year-on-year basis, overall construction outlays were down 3.5 percent in February, compared to down 3.1 percent the month before.
 Motor vehicle sales tend to be a leading indicator of turning points in the economy and they now may be pointing toward contraction for the overall economy. Sales of light vehicles proved unusually weak in March. Total sales, including both domestics and imports, fell 3 tenths to a 15.0 million annual rate for the lowest rate since 1996. Sales of trucks were especially weak, dropping to a 6.1 million rate for domestics from 7.1 million in February, the result no doubt of high gas prices and a nervous consumer. The latest motor vehicle numbers will be leading to some weak estimates for consumer spending in the first quarter – adding to the argument that the quarter was flat at best.
This past week Fed Chairman Ben Bernanke testified before Congress regarding the credit crunch and the takeover of Bear Stearns by JP Morgan. The markets were relieved that there was no indication of another Bear Stearns rescue being planned. But there were a few key tidbits about Bernanke’s view of the economy that are important for future policy.
Bernanke for the first time acknowledged that the economy may turn negative in the first half but he still expects strengthening in the second half. He sees economic growth for 2009 being at or a little above a sustainable pace. On the economy, there is not much new news other than an admission that the economy could be in a recession. In Fed speak, this means the Fed – or at least Bernanke – already sees the economy in a contraction. The Fed traditionally has been reluctant to call for a recession out of concern that the comments could become a self-fulfilling prophecy.
“Overall, the near-term economic outlook has weakened relative to the projections released by the Federal Open Market Committee (FOMC) at the end of January. It now appears likely that real gross domestic product (GDP) will not grow much, if at all, over the first half of 2008 and could even contract slightly.”
While the Fed chairman acknowledged greater economic weakness, he also indicated that much if not all of the solution is already in the pipeline and that recovery is expected soon.
“We expect economic activity to strengthen in the second half of the year, in part as the result of stimulative monetary and fiscal policies; and growth is expected to proceed at or a little above its sustainable pace in 2009, bolstered by a stabilization of housing activity, albeit at low levels, and gradually improving financial conditions. However, in light of the recent turbulence in financial markets, the uncertainty attending this forecast is quite high and the risks remain to the downside.”
Bernanke is hedging his bets but markets see his comments indicating that the odds of further rate cuts have gone down.
Also, Bernanke expects inflation to ease in coming quarters but he issues a number of caveats – indicating that the slowing in inflation is not a done deal.
“We expect inflation to moderate in coming quarters. That expectation is based, in part, on futures markets’ indications of a leveling out of prices for oil and other commodities, and it is consistent with our projection that global growth--and thus the demand for commodities--will slow somewhat during this period. . . . However, some indicators of inflation expectations have risen, and, overall, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully in the months ahead.”
 What few analysts have homed in on is an important admission that likely affects current and future interest rate policy. The Fed chairman basically gave the Fed blame at least in part for current problems, noting that the current situation is an “unwinding of an excessive credit boom” with interest rates “quite low” – implicitly referring to Fed policy after the recession earlier this decade. He said low interest rates “led to unsustainable asset creation” – referring to at least in part to the bubble in housing prices. He noted that the “housing boom was too large.”
This means that the Fed is looking over its shoulder, so to speak, knowing that rates should not go so low again and should not stay low for too long.
Net for the week, the market expectations for the fed funds target rate firmed - especially for 2009.
The consumer sector has weakened further with jobs down three months in a row and with the service sector now flat and no longer providing significant offset to the depressed housing sector and now contracting manufacturing. The good news is that overall weakness is still mild and we have yet to see the full impact of the Fed’s rate cuts and the government's tax rebate checks are not far off. Monetary and fiscal stimulus may still be able to head off a full-fledged recession if credit markets loosen up.
The week ahead is a little slim on economic data with the only market moving indicator being the monthly international trade balance report on Thursday. However, markets will be picking apart the minutes of the latest FOMC meeting – which are released Tuesday afternoon – for any hints on whether the Fed is inclined to ease further.
Consumer credit rose $6.9 billion in January, about as expected and reflecting a $7.0 billion rise in revolving credit which raises serious questions about consumer health. Given the month's soft store sales, the rise in revolving credit likely reflects usage at the gas station and, unfortunately, usage to pay ordinary bills. Non-revolving credit rose a mild $1.1 billion reflecting the month's weak vehicle sales. With the exception of December 2007, revolving credit growth has been accelerating since mid-2007, suggesting that consumers are getting tapped out by rising food and gasoline costs and slowing employment growth. Watching the mix of consumer credit – non-revolving versus revolving – may give hints as to whether the consumer sector has any strength left.
Consumer credit Consensus Forecast for February 08: +$5.3 billion
Range: +$4.0 billion to +$7.9 billion
The Minutes of the March 18 FOMC meeting are scheduled for release at 2:15 p.m. ET. The Fed cut the fed funds target rate by a whopping 75 basis points at this meeting. But with employment falling again, markets are betting on another rate cut later this month and the minutes may give more insight on whether the FOMC is inclined to cut again or whether the dissenters at the March meeting will sway other members to pause.
The pending home sales index is suggesting that just maybe housing is starting to stabilize – although very far upstream only. This index held steady in January, unchanged at 85.9 for a year-on-year decrease of 19.6, a very sizable dip but less severe than December's 24.2 drop. The month-to-month result together with the year-on-year improvement may raise some hopes that the housing sector has stabilized. But not only is it still not a trend for improvement in this index (it could reverse) but it takes some time for the impact to filter through to actual sales and then starts and then actual construction. Nonetheless, this series is where one should look to see the beginning of stabilization in housing.
Pending home sales Consensus Forecast for preliminary February 08: 86.3
Range: 86.3 to 86.3
The U.S. international trade gap has been improving outside of oil and has been the linchpin for strength in manufacturing. The overall U.S. trade gap in January was nudged up by higher oil prices to $58.2 billion from a revised $57.9 billion gap in December. Importantly, the nonoil gap shrank notably, helped not just by higher exports but also by lower nonoil imports. The nonoil trade gap continued its recent narrowing trend, slipping to $32.1 billion in January from $34.8 billion the month before. The petroleum balance, however, did worsen on higher oil prices, growing to $35.1 billion from $31.4 billion in December. With the continued weakness in the dollar and with oil prices continuing to rise, these trends are likely to continue – the nonoil gap is likely to shrink while the oil gap will probably widen.
International trade balance Consensus Forecast for February 08: -$57.5 billion
Range: -$60.0 billion to -55.7 billion
Initial jobless claims spiked 38,000 in the week ending March 29 to 407,000 for the worst reading since Hurricane Katrina in September 2005. Continuing claims also confirmed trouble in the labor market, jumping 97,000 to 2.937 million in data for the March 22 week and the highest reading since mid 2004. The sudden leap of initial claims over the 400,000 level breached a psychological barrier and has raised concern about the depth of current economic weakness. Dipping back below 400,000 would be a boost to equity markets.
Jobless Claims Consensus Forecast for 4/5/08: 386,000
Range: 375,000 to 410,000
Import prices were favorable in February but continued weakness in the dollar and elevated oil and commodity prices put that one month improvement at risk. Import prices rose 0.2 percent in February, following a 1.6 percent spike the month before. 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. A month-to-month downswing in petroleum held back February's month-to-month reading which for non-petroleum shows a steep 0.6 percent rise which follows a 0.7 percent rise in January.
Import prices Consensus Forecast for March 08: +1.8 percent
Range: +0.5 to +2.4 percent
The Reuter’s/University of Michigan’s Consumer sentiment index held mostly steady in March but a weakening labor market and rising gasoline prices could weigh on confidence in April. The Reuters/University of Michigan consumer sentiment report showed only incremental weakness in March, slipping 1.3 points from February to 69.5 in March. Some good news that may only be temporary was a downtick in inflation expectations. One-year inflation expectations slipped 2 tenths to a less elevated 4.3 percent with 5-year expectations unchanged at 2.9 percent.
Consumer sentiment Consensus Forecast for preliminary April 08: 68.0
Range: 66.0 to 70.0
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