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Many economists and investors have built in a recession scenario for the U.S. economy during the first half of 2008. However, this past week’s economic data suggest that the U.S. may dodge recession – but not by much. The numbers are pointing to less weakness than many had expected and that is good. Nonetheless, the economy still has problems and essentially flat growth is to be expected in the near term.
 This past week ended up being good for equities. Economic data were mixed but the main point is that some economic reports were not as negative as feared. Monday was mixed but some optimism for potential M&A activity was aroused by billionaire Warren Buffet’s backing of the acquisition of Wrigley by Mars Inc. Also, auto maker stocks climbed on news that investor Kirk Kerkorian was buying a significant share of Ford. Most stocks dipped on Tuesday on reports that consumer confidence hit another low and that home prices had plunged further. On Wednesday, the Fed’s 25 basis point cut in the fed funds target rate met expectations but equity markets took a “sell on the news” posture. Stocks had rallied earlier in the day on better-than-expected first quarter GDP growth. Markets focused on the FOMC statement as seeing the economy as currently weak.
Thursday saw a broad-based jump in equities with the Dow closing over 13,000 for the first time in almost four months. Thursday’s personal income report was seen as favorable and also helped equity markets become more comfortable with the Fed’s apparent wait and see pause. Also, financials were boosted by a gain in the dollar while techs were lifted by upside earnings surprises from Symantec and Comcast. A better-than-expected jobs report helped equities close mixed on Friday with a jump in oil prices and a surprise loss in earnings by Sun Microsystems weighing on the markets.
Last week, major indexes were up as follows: the Dow, up 1.3 percent; the S&P 500, up 1.1 percent; the Nasdaq, up 2.2 percent; and the Russell 2000, up 0.5 percent.
In April, most major equity indexes had their first net monthly gain since October 2007. The techs led the way, followed by blue chips. In April, major indexes were up as follows: the Dow, up 4.5 percent; the S&P 500, up 4.8 percent; the Nasdaq, up 5.9 percent; and the Russell 2000, up 4.1 percent.
For the year-to-date, major indexes are still down from year end as follows: the Dow, down 1.6 percent; the S&P 500, down 3.7 percent; the Nasdaq, down 6.6 percent; and the Russell 2000, down 5.3 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury rates were little changed last week except for a modest rise in the 3-month T-bill rate. Rates were under downward pressure during the first three days of the week but firmed the last two days, notably on Friday. Rates edged down on Monday as traders awaited an expected cut in the Fed funds target rate with the FOMC announcement on Wednesday. Rates softened a little more on Tuesday with a drop in consumer confidence and in home prices. Treasury prices rallied further on Wednesday as traders focused more on the FOMC statement language that the economy is still weak instead of seeing the statement as equally focusing on inflation. Thursday saw a sizeable stock market rally that pulled funds out of Treasuries and a personal income report that was somewhat better than expected. Rates bumped up again on Friday on a better-than-expected jobs report and on a spike in oil prices.
 On the week rates were as follows: 3-month T-bill, up 12 basis points, the 2-year note, up 3 basis points; the 5-year note, down 1 basis point; the 10-year bond, down 1 basis point; and the 30-year bond, down 1 basis point.
The Fed’s rate cut was expected and with better-than-expected economic data on Thursday and Friday, rates held steady compared to the prior week, further confirming that cycle lows are behind us for interest rates.
 There was no record high set this past week for oil prices – and that is modest good news as prices remain in the stratosphere despite a notable dip for the week. Prices had spiked the prior week on news of a pending strike at North Sea facilities and the early end of that strike sent prices down early this past week. The spot price for West Texas Intermediate fell further on Wednesday on the Federal Reserve’s policy statement that markets interpreted to mean no more rate cuts which boosted the dollar. Oil is traded in dollars and the rise in the dollar eased price pressures. Also on Wednesday, crude supplies came in higher than expected. A further rise in the dollar on Thursday helped nudge oil prices a little lower. But much of the week’s decline was reversed on Friday with a $3.80 per barrel jump in spot prices caused by news of Turkish airstrikes on Kurdish rebels inside Iraq.
Net for the week, the spot price for West Texas Intermediate fell $3.38 per barrel to $116.32 per barrel – $3.38 lower than the record high settle of $119.70 set April 25, 2008.
This past week the April employment report came in better than expected, showing only a small loss in employment. Also, the first reading for GDP in the first quarter indicated that the economy is still growing, albeit just barely. Overall, the economy is not in free fall and given the constraining effects from the credits markets, a flat economy for now can be viewed as a win by investors.
 The April employment report was not nearly as bad as expected and even though the overall number slipped, it was essentially flat. While this is good news, there are still signs of trouble in the housing, manufacturing, and the consumer sectors. Nonfarm payroll employment in April slipped 20,000, following a decline of 81,000 in March and a decrease of 83,000 in February. April’s fall in employment was not as severe as the consensus forecast for a 75,000 drop.
While the overall payroll numbers were not too bad, the construction sector is still depressed and the manufacturing sector appears to be worsening. Construction jobs fell by 61,000 in April, following a 46,000 decline in March. Manufacturing employment fell 46,000 after a 48,000 decrease in March. Natural resources & mining slipped 3,000 in April.
The service-providing sector showed some strength with a 90,000 gain for the latest month. Strength was led by professional & business services and health care while weakness was seen in retail trade.
 On the inflation front, average hourly earnings rose a very modest 0.1 percent in April, following a 0.3 percent gain in March. The average workweek edged down 0.1 hour to 33.7 hours in April. For manufacturing, the average workweek declined more sharply by 0.3 hours to 40.9 Aggregate hours in manufacturing dropped 1.2 percent in April, following a 0.1 percent decrease the month before.
While the essentially flat overall payroll figure was seen as a positive by the markets, there still are some troubling signs in the report – although not dramatically more so than recent data. While the drop in construction employment is not surprising, the sharp drop in manufacturing employment is a little worrisome. This and a 1.2 percent fall in manufacturing work hours in April indicates that industrial production is likely to decline notably for the month. Essentially, housing and manufacturing will be tugging the economy downward for the month.
What about the consumer sector? While income growth has been healthy through March, that may be changing. Average hourly earnings rose a meager 0.1 percent in April and the workweek edged down, suggesting sluggish wages & salaries growth for the month. Also, employment in retail trade fell 27,000 in April, indicating that businesses are either seeing a slowing in sales or expect a slowing.
April’s decline in payroll employment was the fourth in a row. Does this mean recession? The best answer should first note that recession is based on output and not simply on employment. During periods of modest employment declines, output can still grow due to labor productivity. To get declines in output requires continued declines of payroll employment exceeding 100,000 per month for a number of consecutive months. We have not seen that yet. While there are some notable warning signals in the April employment report, the best interpretation for now is that the economy is flat and is likely to stay near flat for some months.
Turning to the household survey, the civilian unemployment rate slipped to 5.0 percent from 5.1 percent in March. Household employment jumped 362,000 in April while the number of unemployed fell 189,000. The household survey has a much smaller sample size than the payroll survey and is more volatile on a monthly basis.
 The initial estimate for first quarter GDP is keeping the economy out of the technical definition of recession – but just barely. Real GDP came in at an annualized 0.6, matching the fourth quarter’s 0.6 percent annualized increase.
While the overall growth number was soft, the composition was reasonably balanced, given the known problems in housing and with consumers becoming more cautious. The modest rise in real GDP reflected continued strong exports, a small rise in inventories, and continued healthy services personal consumption. Weakness was seen in declines in durables and nondurables PCEs, nonresidential fixed investment, and in residential investment.
Final sales to domestic purchasers did turn negative, falling an annualized 0.4 percent, after rising 1.3 percent in the fourth quarter. This confirms that the economy has been kept positive by export growth and to a modest degree by a rise in inventories. But a $1.8 billion rise in first quarter inventories is trivial when following an $18.3 billion drop the prior quarter. There is no reason to expect inventory overhang (which does not exist to any notable degree) to weigh on manufacturing.
Although inflation numbers were better than expected, they are still on the high side. The first quarter GDP price index firmed to an annualized 2.6 percent boost from the prior quarter’s 2.4 percent. Also, the headline PCE price index was still rather hot, rising an annualized 3.5 percent in the first quarter after a 3.9 percent jump the quarter before. The core PCE price index growth rate eased to up 2.2 percent in the first quarter, compared to up 2.5 percent in the prior quarter.
 Personal income in March came in moderately healthy but there were signs of weakness on the spending side. Personal income in March advanced with a 0.3 percent increase, following a 0.5 percent gain in February. Within personal income, the wages and salaries component posted a robust 0.5 percent gain, following a moderate 0.3 percent gain the month before.
 At first blush, spending looked good as personal consumption rose 0.4 in March after edging up 0.1 percent in February. But spending was led by a jump in services with nondurables also boosted by higher gasoline prices. Durables fell in the latest month. Once the numbers were adjusted for inflation, not much strength was left. Real PCEs edged up only 0.1 percent in March after being flat the prior month.
Higher prices boosted spending and that showed up in overall inflation. The headline PCE price index firmed to a 0.3 percent increase in March, following a modest 0.1 percent uptick in February. The core PCE price index firmed but to a more moderate 0.2 percent from 0.1 percent in February. But the bottom line is that the inflation trend is still high, mainly boosted by food and energy costs. On a year-on-year basis, headline PCE inflation was still at a strong 3.2 percent pace in March.
 While the latest employment report looks grim for manufacturing, various surveys suggest this sector is leveling off. Steady and flat are the best words to describe the ISM manufacturing report where the main index was unchanged at 48.6 in April, just under the breakeven 50 level to indicate very slight month-to-month contraction in business conditions. But new orders unfortunately contracted at a steeper rate, unchanged at 46.5 in April. But exports are still a big positive as export orders were up 1 point to 57.5 to indicate significant expansion.
 The Chicago purchasers report showed steady month-to-month conditions with their index little changed at just below the break-even 50 level, at 48.3 in April for a 1 tenth gain from March. On a more positive note, new orders showed a mild month-to-month increase, at 53.0 – only marginally slowed than the 53.9 reading for March.
The bottom line is that various surveys are showing manufacturing output to be holding up better than manufacturing employment (although the NAPM Chicago report does include nonmanufacturing firms).
 Construction spending in March returned to negative territory, led down by housing. Construction outlays fell 1.1 percent, following a 0.4 percent rebound in February. The March decline in construction spending was led by a 4.6 percent drop in private residential outlays. However, private nonresidential construction firmed with a 1.9 percent jump while public outlays posted a healthy 0.6 percent gain. The key point is that non-housing components of construction appear to be making a modest comeback – indicating that there are additional sources of growth for the economy.
 The Fed took out a little more anti-inflation insurance this past week with another interest rate cut but the Fed appears to be signaling a pause in any additional rate cuts. The FOMC cut the fed funds rate by 25 basis points to 2.0 percent as expected. But some FOMC members were not happy with the decision. The vote was 8 to 2 in favor of the cut with Dallas Fed President Richard Fischer and Philadelphia Fed President Charles Plosser dissenting, preferring no change at this meeting. The Fed has cut the fed funds target rate seven times this rate cutting cycle starting on September 18, 2007 for a cumulative total of 325 basis points. The discount rate also was cut by 25 basis points today and is now 2.25 percent. The FOMC statement noted both risks to growth and to inflation and does not appear to indicate a bias either way while at the same time maintaining flexibility for further rate cuts.
Indeed, the FOMC appears to be equally concerned potentially weak growth and about inflation. The minutes start out focusing on risks to growth, pointing to sluggish consumer and business spending and credit crunch related issues.
But the Fed may be signaling a pause as, after taking into account the cumulative effect of past cuts, they see inflation easing and growth improving over time.
"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."
"The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity."
These two statements combined are about as close as one can get to the Fed explicitly stating that risks are balanced -- the Fed only recently began to not explicitly state its policy bias in the statement. As usual, the Fed stated it will continue to monitor economic and financials developments and will as act needed.
And the Fed gave another indication that it may be pausing with rate cuts with an announcement this past Friday morning just before the employment report. That is, the Fed appears to be relying more and more on directly impacting the credit markets through new facilities. The Fed announced an expansion of the securities that it accepts for its Term Securities Lending Facility (TSLF) auctions and announced other expansions of its credit market tools. The Federal Open Market Committee authorized an expansion of the collateral that can be pledged in the Federal Reserve's Schedule 2 Term Securities Lending Facility (TSLF) auctions. Primary dealers may now pledge AAA/Aaa-rated asset-backed securities, in addition to already eligible residential- and commercial-mortgage-backed securities and agency collateralized mortgage obligations, beginning with TSLF auction to be announced on May 7, 2008, and to settle on May 9, 2008.
Also, the Fed announced an increase in the amounts auctioned to eligible depository institutions under its biweekly Term Auction Facility (TAF) from $50 billion to $75 billion, beginning with the auction on May 5. Finally, the same announcement expanded swap arrangements with the Swiss National Bank and the European Central Bank. All of these actions help the Fed improve credit markets and are not related to rate cuts. The Fed is putting itself in position to not need further rate cuts to manage credit needs.
 Net for the week, markets are now starting – emphasizing just starting – to focus on the fact that the Fed is now starting to think about when it needs to start raising interest rates. This has already been factored into the fed funds futures market and currently traders see rates heading back up in early 2009. Implied rates were particularly boosted by this past week’s personal income and employment reports.
The U.S. economy stayed out of recession through the first quarter – at least according to technical definitions. But growth is still flat and data revisions could nudge the numbers into negative territory. Importantly, there still are serious problems in housing, manufacturing is flat, and there are significant questions about the strength of the consumer sector. Odds are we will get a marginally negative second quarter and if we get the second half rebound that the Fed and others anticipate, the economy may still technically avoid being in recession. But it won’t feel much differently with growth likely anemic.
This coming week is relatively light on economic data with the only major indicator being monthly international trade. But we also get important readings on the labor sector with the weekly jobless claims and with an update on pending home sales – an early signal for changes in the housing sector.
The business activity index from the ISM non-manufacturing survey in its most recent report for March indicated that the sector is flat rather than in recession. The ISM's composite index was little changed, up 3 tenths from February at 49.6 -- a nearly dead even 50 reading indicating an even split between those purchasers reporting contracting conditions and those reporting expanding conditions. New orders also improved to a break-even level of 50.2. As have been indicated by essentially all surveys, inflation is worsening as indicated by the prices paid index which was up nearly 3 points to 70.8.
Business activity index Consensus Forecast for April 08: 49.3
Range: 47.5 to 50.0
Nonfarm productivity has been weak due to the fourth quarter slowdown in output. Fourth quarter productivity came in at an annualized 1.9 percent. Raising the specter of inflation pressures rising in the labor sector was a 2.6 percent increase in fourth quarter unit labor costs. While first quarter GDP was just as anemic as the fourth quarter with a 0.6 percent annualized gain, we could see some improvement in productivity and labor costs as hours worked appeared to slow in the latest quarter.
Nonfarm Productivity Consensus Forecast for initial Q1 08: +1.7 percent
Range: +0.8 to +2.2 percent
Unit Labor Costs Consensus Forecast for initial Q1 08: +2.6 percent
Range: +1.5 to +3.5 percent
The pending home sales index has not yet given signs of hope for a turnaround in housing. In fact, the latest reading pointed in the other direction. The pending existing-home sales index fell 1.9 percent in February to 84.6. The year-on-year rate slipped to minus 21.4 percent in February, pointing toward continued weakness in existing home sales.
Pending home sales Consensus Forecast for March 08: 83.8
Range: 82.8 to 85.0
Consumer credit growth slowed in February, to a rise of $5.2 billion from a steep $10.3 billion jump in January. Even revolving credit -- that is credit card use -- rose a more moderate $4.7 billion compared a gain of $5.6 billion in January. Non-revolving credit -- consisting mainly of auto loans -- rose only $0.5 billion, reflecting the month's weak vehicle sales. The consumer sector and credit growth are slowing due to fears of job losses, tighter credit, and less available home equity. But the growth of revolving credit relative to retail sales is important to watch to see if consumers are becoming more cash strapped for meeting daily needs such as higher priced groceries and gasoline.
Consumer credit Consensus Forecast for March 08: +$6.0 billion
Range: $3.0 billion to +$7.5 billion
Initial jobless claims jumped 35,000 in the week ending April 26 380,000, indicating that the economy is still sluggish and that firms are in a cost cutting mood. Continuing claims, in data for the April 19 week, jumped 74,000 and at 3.019 million were above the 3 million level for the first time in four years. But the claims numbers are volatile and the four-week averages are showing less weakness with initial claims down 6,500 to 363,750 and with the average for continuing claims still below 3 million at 2.979 million.
Jobless Claims Consensus Forecast for 5/3/08: 370,000
Range: 355,000 to 390,000
The U.S. international trade gap has been buffeted by swings in oil prices and most recently by bad guesses by U.S. businesses on the strength of the consumer. The U.S. trade balance in February surprisingly worsened, growing to $62.3 billion from a $59.0 billion shortfall in January. For the latest month, exports rose 2.0 percent while imports jumped 3.1 percent. Also unexpectedly, the oil gap narrowed while the nonoil gap expanded sizably. The petroleum gap shrank to $32.5 billion from $35.3 billion in January. The nonoil trade gap widened to $37.8 billion from $32.5 billion the month before, boosted by a jump in imports for automotive and consumer goods -- where demand is soft. For March, we are likely to see a reverse of some of February’s components as oil imports are likely to be boosted by higher prices while nonoil imports could slow to offset rising inventories. However, the slowing in nonoil imports may take one or two months longer as there is a long lag between orders for imports and their actual entry into U.S. ports and into the data.
International trade balance Consensus Forecast for March 08: -$60.8 billion
Range: -$64.5 billion to -$58.0 billion
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