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For almost a year, the Fed has taken repeated actions to stabilize credit markets following the breakout of the subprime crisis. Then, as credit markets appeared to stabilize after each crisis the Fed solved, another credit market crisis seems to pop up. This past week, the Fed (and Treasury) had to deal with market belief that Fannie Mae and Freddie Mac were close to insolvency. Meanwhile, the Fed increasingly is facing the dilemma of slow economic growth and rising inflation.
 Equities rebounded smartly this past week although at the start, it certainly did not look that way. The three primary drivers of equity prices this past week were credit market concerns, oil prices, and the Fed’s view of the economy.
Credit market concerns took center stage well before trading started for the week as markets had barely closed the prior week when the FDIC took over California bank IndyMac due to pending insolvency. Despite the Fed and Treasury announcing steps on Sunday evening to support mortgage financiers Fannie Mae and Freddie Mac, markets worried about the stability of the credit markets – especially with earnings reports from the financial sector pending the same week and shortly thereafter. IndyMac reopened on Monday under federal supervision and a new name – IndyMac Federal Bank – but the attention on the California bank kept markets jittery. Adding to the worries about financial institutions was a report early in the week by Lehman Brothers that predicts a dramatic jump in loan losses for Washington Mutual.
Adding to market woes early in the week was testimony before Congress by Fed Chairman Ben Bernanke. His semiannual testimony presented a rather gloomy economic picture of sluggish economic growth and high inflation in the near term. Early in the week, credit market and stagflation concerns weighed on equities.
Meanwhile, oil prices started a sharp weekly decline on Tuesday which continued the remainder of the week. Net, the spot price of crude fell almost $16 per barrel and energized stocks substantially. Lower oil prices especially boosted transports. Additionally, Delta and American Airlines helped transports and broad indexes by reporting lower-than-expected losses.
And during the latter part of the week, financials turned themselves back up sharply and the rest of the market to a lesser degree as key financial firms reported lower than expected second quarter losses (JP Morgan Chase and Wells Fargo). A view also took hold that the IndyMac failure may represent the bottom for the financial sector.
The good news for the week included a sharp drop in oil prices and reports that companies are starting to come to grips with higher costs from the run up in oil prices. Other good news includes simply getting past the IndyMac, Fannie Mae, and Freddie Mac crises with renewed optimism about the financial sector. The bad news is that the economy is not going to be in good shape for a while – but the equity markets appear to be very forward looking at this point and are anticipating better times ahead.
This past week, major indexes were up as follows: the Dow, up 3.6 percent; the S&P 500, up 1.7 percent; the Nasdaq, up 2.0 percent; and the Russell 2000, up 2.7 percent.
For the year-to-date, major indexes are down as follows: the Dow, down 13.3 percent; the S&P 500, down 14.1 percent; the Nasdaq, down 13.9 percent; and the Russell 2000, down 9.5 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Despite an uncertain start this past week, the bond market now appears to be doing part of the Fed’s job of fighting inflation by nudging rates up. But first, the stability of the credit markets has been an off and on worry for Treasuries and this past week was not an exception as concerns over IndyMac, Fannie Mae, and Freddie weighed on yields on flight to safety. Comments by Fed Chairman Ben Bernanke about “difficulties” facing the economy also added to flight to safety.
But at mid-week, two factors re-emerged to boost rates – rampant inflation at the consumer and producer levels and a return of confidence in equities. The latter was based in large part on financial firms reporting lower-than-expected second quarter losses. Even though economic data for housing, manufacturing, and consumer spending were sluggish at best, the bond market focused on sharp spikes in the PPI and CPI reports for June. The bond market is now focusing its attention on inflation and, in turn, is bumping rates up.
 For this past week Treasury rates were up except on the near end as follows: 3-month T-bill, down 11 basis points, the 2-year note, up 5 basis points; the 5-year note, up 14 basis points; the 10-year bond, up 14 basis points; and the 30-year bond, up 14 basis points.
Longer term yields have been boosted in recent days by renewed inflation fears and reversal of flight to safety.
 Oil prices fell dramatically last week but remain quite high. Prices fell primarily due to the increased view that high prices and a sluggish economy are cutting into demand. Notably, comments by Fed Chairman Ben Bernanke that high energy prices will be a drag on consumer spending and the economy as a whole started on Tuesday a four-day drop in prices. Bernanke’s comments helped pull crude down by well over $7 per barrel on Tuesday. Adding to the view that consumers are responding to higher gasoline prices was an unexpectedly sharp run up in oil inventories. Wednesday’s oil inventory report pushed spot crude down by almost $3 per barrel. An easing in tensions between the U.S. and Iran played a key role in bumping oil down another $5 on Thursday on reports that the U.S. may be soon establishing a diplomatic interest section in Tehran.
Net for the week, spot prices for West Texas Intermediate dropped a whopping $16.20 cents per barrel to settle at $128.88 – and coming in $16.41 below the record settle of $145.29 per barrel set on July 3.
News on the economy was dominated by a run up in inflation numbers and by gloomy news from the Fed. On top of that, the regular economic reports showed sluggishness in the consumer sector, manufacturing, and housing.
Higher energy costs have caused consumer price inflation to turn red hot. In June, the headline CPI soared 1.1 percent, following a 0.6 percent surge the month before. But there may be signs that the core rate is starting to be affected by higher food and energy costs bleeding into it through cost or expectation effects. The core rate firmed to a 0.3 percent increase after a 0.2 percent rise in May.
Once again, energy led the surge in overall inflation with a monthly 6.6 percent increase, following a 4.4 percent gain in May. Gasoline was up a monthly 10.1 percent after rising 5.7 percent in May. Food inflation accelerated sharply with a 0.8 percent jump in June, following 0.3 percent increase the month before.
 While energy has been getting most of the attention, food price inflation has picked up sharply, also. The food component jumped a monthly 0.8 percent in June after a 0.3 percent boost the month before. Food is up 5.3 percent on a year-ago basis (not seasonally adjusted). Higher grain costs and higher fuel costs have helped drive up food prices. Indeed, the food subcomponent showing the largest year-ago increase is the cereals & bakery products index with a 10.4 percent increase. The food index would be even higher other than what may surprise many – the softness in the meats, poultry, fish & eggs subcomponent which has risen just 2.9 percent over the last 12 months. But this softness is largely due to some cattle herders dumping livestock on the market because they cannot afford the grain for feed. Eventually, this part of the cattle cycle will play out and meat prices will rise notably.
 There are beginning to be signs that the core rate is heating up, too. Recreation and education & communication were up 0.5 percent and 0.4 percent, respectively. Housing was up 0.5 percent also but much of the increase was energy related as the shelter subcomponent was a more moderate 0.3 percent in the latest month. On the soft side were apparel, up 0.1 percent; recreation, up 0.1 percent; and medical care, up 0.2 percent. But apparel has actually firmed compared to typical monthly declines, indicating that imported inflation is hitting the consumer.
Year-on-year, the overall CPI jumped to up 4.9 percent in June (seasonally adjusted) from up 4.1 percent in May. The core rate edged up to up 2.4 percent, compared to up 2.3 percent in May. The headline year-ago rate is at its highest since 5.6 percent for January 1991.
 Further strong gains for consumer prices are likely at least at the headline level as price pressure is still in the pipeline. The overall PPI inflation rate remained red hot in June with a 1.8 percent jump, following a 1.4 percent spike the month before. The core PPI rate, however, held steady at a 0.2 percent rise and fell short of market expectations for a 0.3 percent gain.
The headline number was led by a monthly 6.0 percent surge in energy costs and a 1.5 percent gain in food prices. Within energy, gasoline spiked 9.0 percent for the month and is up 39.7 percent for the year.
Helping to keep the core rate moderate was a 1.8 percent decline in prices for light trucks, although passenger cars rebounded 2.2 percent. Also weak were pharmaceuticals, down 0.1 percent, and tobacco products, unchanged.
Producers cannot always pass along costs to consumers as much as they would like. However, higher food and energy costs have trended upward sharply and manufacturers are under pressure to boost prices in many industries. The food component is up 9.2 percent year-on-year (not seasonally adjusted) while energy is up 27.0 percent (gasoline, up 39.7 percent).
For the overall PPI, the year-on-year rate jumped to up 9.1 percent from 7.2 percent in May (seasonally adjusted). The core rate rose to up 3.1 percent from up 3.0 percent in May.
 With income tax rebate checks still circulating, many had expected June sales to be healthy. But that was not to be as overall retail sales posted only a modest 0.1 percent in gain in June, following a 0.8 percent boost the month before. Income tax rebate checks apparently went mostly into drivers' gasoline tanks. Excluding motor vehicles, retail sales increased a strong 0.8 percent in June, after advancing 1.2 percent the month before. However, the strength was mostly due to higher gasoline prices. When excluding both motor vehicles and gasoline, sales advanced 0.2 percent, after rising 0.8 percent in May.
Indeed, inflation largely led retail sales as the strongest component was gasoline stations with a 4.6 percent boost in June. Food and beverage stores also posted a sizeable increase at 0.7 percent. Other strength was in nonstore retailers and clothing & apparel.
Weakness was led by building materials & garden equipment and by motor vehicles & parts.
The June slowing in retail spending will end up damping second quarter GDP growth due to this series being key source data for personal consumption expenditures. Thus far, the second quarter GDP number looks likely to be positive but not by a lot.
 Industrial production rebounded sizably in June, but the headline number is misleading as manufacturing was nowhere near as strong. Overall industrial production rebounded 0.5 percent in June, following a 0.2 percent decline in May. But the headline figure was led by a 2.1 percent jump in utilities output and also a 1.1 percent boost in mining. The manufacturing component made a more modest 0.2 percent comeback, after slipping 0.1 percent in May.
Although the manufacturing component did rise in June, strength was led by a monthly 5.4 percent jump in motor vehicle output which followed a 0.6 percent rise in May. Excluding motor vehicles, manufacturing output slipped 0.1 percent - the same as in the prior month. Other components were mixed. The bottom line is that after utilities, mining, and motor vehicles are taken out, manufacturing is very sluggish and even mildly negative net.
 Regional manufacturing surveys continue to point to shrinkage in the manufacturing sector. At least for the New York State area the slippage lessened as the Empire State's general business conditions index did show improved to a minus 4.9 reading in July from minus 8.7 in June. However, there are signs of potential improvement ahead as readings for both new orders and shipments were both solidly positive, at 8.3 and 13.5.
The inflation numbers in the report were disconcerting. Prices paid set a new record high at 77.9, up sharply from 66.3 in July. But the truly worrisome part is that prices received also set a new record high at 32.6 for July and was up from 26.7 the prior month. This indicates that manufacturers’ rising costs are being passed through to final goods. The economy is not soft enough at the demand level to constrain cost push inflation for an increasing number of producers.
 Manufacturing in the Philly Fed region appears to be one the hardest hit areas by the economic slowdown. The Philly Fed’s index has been very negative and July’s reading of minus 16.3 extended the number of consecutive negative readings to eight months. The July posting was marginally less worse than the minus 17.1 for June. In contrast to the Empire State report, the near-term outlook does not look good. New orders continue to contract, coming in at minus 12.1 versus June's minus 12.4, with shipments also contracting, at minus 8.0 in July from minus 6.7 the month before.
Price data from the Philly survey were just as worrisome as those from New York. The input price index shot up to up to 75.6 from 69.3 in June. The prices received index remained elevated at 28.8 versus 29.7 in June. Cost pressures are widespread.
 Housing starts jumped significantly in June but the “improvement” was entirely due to more restrictive permit regulations being enacted for New York City. Starts rebounded 9.1 percent, following a 2.7 percent decline in May. The June pace of 1.066 million units annualized was down 26.9 percent year-on-year and was above than the market forecast for a 0.960 million units.
However, the June rebound was led by a 42.5 percent monthly surge in multifamily starts as single-family starts fell 5.3 percent. The surge in multifamily starts reflected the enactment of more restrictive building codes in New York City effective July 1, 2008 which created a rush to get permits before that date which in turn boosted starts.
The single-family component of starts fell further to pace of 0.647 million which was down from 0.683 million in May and was down 43.0 percent on a year-ago basis.
There are several key points from the latest starts report. First, of course, is that the June rebound was artificial and temporary. Second, starts levels likely will be depressed for a number of months. Permits and starts in New York City will fall in July and stay low for some time as projects that would have been spread out over a number of months were rushed to be the July 1 effective date of more restrictive building code. Lastly, the single-family sector is still on a downtrend and over supply of new and existing homes on the market suggest that is not going to change soon.
The Fed is having a hard time “winning.” Just as financial markets seem to be settling down in response to Fed actions, another crisis seems to come along and require Fed attention. This past week was no exception as both the Fed and the Treasury put in a long weekend to start the week. And by mid-week, it was clear that the Fed has tough choices from facing weak economic growth and rising inflation pressures.
Last week started early as the Federal Reserve and the Department of the Treasury on Sunday evening made separate announcements that they were taking actions to bolster confidence in mortgage finance companies Fannie Mae and Freddie Mac. To calm the credit markets, the Federal Reserve opened its discount window to the two agencies while the Treasury announced planned legislation to allow the Treasury to 1) give the agencies a temporary increase in their line of credit with the Treasury, 2) to give the Treasury temporary authority to buy equity (stock) in either of the two GSEs if needed, and 3) give the Fed a consultative role in setting capital requirements and other standards for the GSEs.
The moves by the Fed and the Treasury were critical. The two GSEs either own or back about half of the mortgage debt in the U.S. Also, the securities issues by them are owned by major banks, some mutual funds, some pension funds, and by foreign governments. The takeover of California bank IndyMac by the FDIC after close the prior Friday likely played a role in the Fed and Treasury moves on Sunday evening as a crisis of confidence was developing over the weekend.
Fed Chairman Bernanke gave his semiannual testimony to Congress this past Tuesday and Wednesday and on Wednesday the minutes of the June 24-25 FOMC meeting were released. The testimony was more up-to-date and reflected the adverse impact of Fannie Mae and Freddie Mac concerns on the credit markets along with the takeover of IndyMac by the FDIC. The FOMC minutes reflected the Fed’s view of the economy three weeks earlier.
While the FOMC minutes included Fed forecasts for a modest rebound in economic growth and higher near-term inflation, Bernanke’s testimony indicated that the outlook for real growth had been downgraded somewhat due to the backtracking of improvement in credit markets. While the Fed worries about both growth and inflation, the Fed chief made it clear that the immediate top prior was to stabilize the credit markets.
“In general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve.”
The FOMC’s outlook for real growth is very similar to its April forecast – real growth is sluggish in the near term and returns to trend by 2010. As in the past, current weakness primarily is related to depressed housing and tight credit conditions with a rebound in growth largely dependent upon an improvement in housing and a return of normal credit market functioning.
“On balance, most FOMC participants expected that, over the remainder of this year, output would expand at a pace appreciably below its trend rate, primarily because of continued weakness in housing markets, elevated energy prices, and tight credit conditions. Growth is projected to pick up gradually over the next two years as residential construction bottoms out and begins a slow recovery and as credit conditions gradually improve.”
The Fed Chairman warned that inflation risks have risen, stated his concern about consumers boosting inflation expectations, and even that a wage-price spiral could occur without proper vigilance.
“At the same time, upside risks to the inflation outlook have intensified lately, as the rising prices of energy and some other commodities have led to a sharp pickup in inflation and some measures of inflation expectations have moved higher. Given the high degree of uncertainty, monetary policy makers will need to carefully assess incoming information bearing on the outlook for both inflation and growth. In light of the increase in upside inflation risk, we must be particularly alert to any indications, such as an erosion of longer-term inflation expectations, that the inflationary impulses from commodity prices are becoming embedded in the domestic wage- and price-setting process.”
 The FOMC minutes of the June 24-25, 2008 meeting showed a sharp internal debate over the risks of inflation. The “hawks” on the FOMC are worried that a negative real fed funds rate will lead to higher inflation and possibly a wage-price spiral. Indeed, the real fed funds rate is likely somewhere between zero and negative 1, depending on which measure of the personal consumption price index is used.
Those on the committee who are worried about growth risks point to an economy held back by weak housing and other factors. Despite continuing downside risks to growth, the overall view was that a rise in inflation was the greater concern. Some members indicated that not only should the next rate change be up, but that it should be eminent. But a key point is that financial markets have changed substantially since the June 24-25 meeting, with the moves by the Fed and Treasury to support Fannie Mae and Freddie Mac and with the FDIC closing IndyMac Bank. At this past week’s Congressional testimony, Chairman Bernanke essentially downgraded the forecasts for economic growth that had been included in the latest minutes but had been prepared more than three weeks earlier.
What is the Fed to do – how can the Fed win? The Fed is in a difficult position. Many FOMC members rightfully are worried about a rise in inflation and that the Fed – because of lags in the impact of monetary policy - should move now to preclude a locking in of higher inflation rates. But financial markets are fragile and Bernanke has indicated that restoring financial stability is the top priority. Fighting inflation is now on pause but perhaps not for too long.
The Fed has tough choices ahead in terms of stabilizing the credit markets, keeping the economy out of recession, and staving off a boost in inflation. But for now, Fed Chairman Bernanke has placed stabilizing the credit markets as top priority – with the fight against inflation being put on pause. But Bernanke may get more dissents from regional Fed banks to start boosting rates.
The only market moving indicator this coming week is durable goods orders on Friday. Also getting attention will be the Fed’s release of the Beige Book on Wednesday. We also get key updates on the housing sector for both existing home and new home sales. Fed Chairman Bernanke has repeatedly stated that stabilization in the housing sector is critical to overall growth for the economy.
The Conference Board's index of leading indicators is not now pointing to recession but rather to an extremely sluggish economy. The leading index in May inched 0.1 percent higher for a second straight month. Generally, there needs to be three consecutive significant declines before the index correctly forecasts recession. But financial markets were a plus for May's data, perhaps a weak link that will shift in June. The coincident index, which is closely watched by the National Bureau of Economic Research for indications on the business cycle, advanced 0.1 percent following two prior months of 0.1 percent decreases -- results that again point to flat conditions.
Leading indicators Consensus Forecast for June 08: -0.1 percent
Range: -0.4 to +0.1 percent
The Beige Book being prepared for the August 5 FOMC meeting is released this afternoon. There is no shortage of issues for the Beige Book to update – stability of credit markets after IndyMac, Fannie Mae, and Freddie Mac; signs of building wage pressures; signs of weaker growth; whether housing is leveling off; and whether food and energy inflation are seeping into core inflation.
Initial jobless claims rebounded in the latest week but at only a fraction of the magnitude of the prior week’s drop. Initial claims rose 18,000 in the week ending July 12, following a sharp 56,000 drop in the prior week – a week shortened by the Independence Day holiday. The four-week average fell 4,500 to 376,500, little changed from the 376,000 average in the June 14 week. While initial claims have oscillated around a trend level that is not too worrisome, that cannot be said for continuing claims. Continuing claims for the July 5 week fell 81,000 to 3.122 million. But the four-week average continues to rise, up 16,500 to 3.143 million for the highest rate in 4-1/2 years. Firms appear to be both reluctant to lay off workers and reluctant to hire.
Jobless Claims Consensus Forecast for 7/19/08: 375,000
Range: 370,000 to 440,000
Existing home sales gave hints of being near bottom in May but dire problems remain with unsold inventories. Sales of existing homes rose 2.0 percent in the month to a 4.990 million annual rate, the best rate since February and the second best since November. Supply improved marginally but remains extremely swollen, slipping to 10.8 months from 11.2 months in April. The median price rose 3.7 percent in May to $208,600 but stood 6.3 percent lower year-on-year.
Existing home sales Consensus Forecast for June 08: 4.94 million-unit rate
Range: 4.90 to 5.20 million-unit rate
Durable goods orders have been volatile as usual but have been trending near flat in recent months. May's numbers fit right in with that trend coming in unchanged following a 1.0 percent dip the prior month. Most of May’s strength was in aircraft orders as durables excluding transportation fell back 0.8 percent, following a 1.9 percent surge in April. April was revised down somewhat for both overall orders and ex-transportation. For the latest month, strength was in civilian and defense aircraft orders.
New orders for durable goods Consensus Forecast for June 08: -0.4 percent
Range: -1.0 percent to +0.5 percent
The Reuter's/University of Michigan's Consumer sentiment index continues to indicate that the U.S. consumer is deeply concerned about the economy as the latest reading showed only incremental improvement from a depressed level. The Reuters/University of Michigan's consumer sentiment index inched higher in mid-July to 56.6 from June’s month-end reading of 56.4. Unfortunately, inflation expectations are drifting up. One-year inflation expectations jumped 2 tenths in July month to 5.3 percent with 5-year expectations unchanged at 3.4 percent. The latest consumer sentiment report offers a condensed version of the dilemma faced by the Fed – whether to worry more about economic growth or about rising inflation.
Consumer sentiment Consensus Forecast for final July 08: 56.4
Range: 56.0 to 57.5
New home sales continue to fall further into recessionary levels. Sales fell 2.5 percent in May to an annualized sales rate of only 512,000 units. Sales levels are lower than during the 2001 recession and are comparable to the sales pace during portions of the recessions of 1990-91, 1981-82, 1980, 1973-74, and 1970. New home prices, which have held up better than prices for existing homes, finally started to give in, falling 5.1 percent in May to a median $231,000 and down 5.7 percent year-on-year. The months' supply on the market worsened to 10.9 months from 10.7 months in April.
New home sales Consensus Forecast for June 08: 505 thousand-unit annual rate
Range: 490 thousand to 520 thousand-unit annual rate
Econoday Senior Writer Mark Pender contributed to this article.
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Consumer price inflation flares up