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When does it end? This past week, the Sunday rescue/takeover of Fannie Mae and Freddie Mac made the spotlight on the financial sector even hotter. And the collapse of Lehman Brothers appeared imminent. Meanwhile, economic data point to a soft consumer sector. There was some good news – at least temporary improvement in inflation.
 Equities ended the week up despite the Sunday afternoon surprise of the Treasury and other regulators announcing the placing of Fannie Mae and Freddie Mac into conservatorships. Equities generally rallied on Monday as the move was seen as soothing the credit markets and even lowering mortgage rates. The takeover plan included the Treasury buying over time a sizeable portion of Fannie and Freddie’s mortgage backed securities. This was seen as liquefying the mortgage market. The net effect of the takeover – among others – included the likely speeding up the housing recovery (albeit still slow). And equities liked that implication. Financials and homebuilders would be notable beneficiaries in terms of stock price gains. Some regional banks slumped, however, as some were known to hold notable amounts of Fannie and Freddie stocks which have become almost worthless with the takeovers.
But the general euphoria was short-lived as it became better known that Lehman Brothers was not finding a white knight to buy it and recapitalize the company. This further made it difficult for Lehman to raise capital. Downgrades to Lehman raised worries that many financial firms would end up with larger losses than already announced. Lehman reported a nearly $4 billion fiscal third-quarter loss. Renewed fears about the financial sector helped to bring equities down on Tuesday. Also, a drop in pending home sales weighed on equities, especially homebuilders.
But financials turned around somewhat on Thursday after a published report that Lehman was still actively pursuing a buyer with Bank of America believed to be a likely candidate. A drop in oil prices lifted stocks in general and transports in particular.
While there are still many worries for the equity markets, the surprising thing about the past week is that most indexes ended the week positive. Despite the likelihood of a slowing economy, traders appear to believe that equities have hit the cycle low and seem content to trade sideways.
Equities were up this past week. The Dow was up 1.8 percent; the S&P 500, up 0.8 percent; the Nasdaq, up 0.2 percent; and the Russell 2000, up 0.2 percent.
For the year-to-date, major indexes are down as follows: the Dow, down 13.9 percent; the S&P 500, down 14.8 percent; the Nasdaq, down 14.7 percent; and the Russell 2000, down 6.0 percent.
Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.
 Treasury yields moved mainly sideways this past week and ended mixed. Bond markets were relatively tame as Treasury’s arranged takeover of Fannie Mae and Freddie Mac helped to sooth the credit markets. Modest movement within the week was largely related to flight to safety relative to equities. Yields edged down on Tuesday as stocks dropped. Rates firmed late in the week as equities rallied. Net, there was some downward pressure on the near end as a growing minority of traders increased chatter that the Fed’s next rate move is down instead of up.
 For this past week Treasury rates were mixed as follows: 3-month T-bill, down 19 basis points, the 2-year note, down 4 basis points; the 5-year note, up 4 basis points; the 10-year bond, up 7 basis points; and the 30-year bond, up 5 basis points.
The softening economy and the growing minority of traders who see the Fed cutting rates again before raising them have led short rates to ease somewhat relative to long rates.
 Crude oil prices tumbled further last week despite Hurricane Ike squarely aiming at Texas’ oil refineries and an OPEC announcement cutting production quotas. Traders are now focusing more on demand than on supply and demand clearly is slowing.
But OPEC had notable impact last week. Prices were bumped down on Tuesday – the day before OPEC’s meeting – on comments by OPEC officials that the organization would not likely cut production. Some OPEC members fear triple digit oil prices will hasten the development of substitute energy, undermining the oil market. Prices firmed somewhat on the actual announcement on Wednesday of production cuts but weakened later on comments by leading producer Saudi Arabia that it is not planning to cut production.
Demand is becoming an issue. Economies overseas are experiencing slower growth with a few countries likely already in mild recession. In the U.S., demand also is slowing, as indicated by the August retail sales report just released. Traders are especially focusing on this softness after the International Energy Agency this past Wednesday lowered its forecast for global oil demand in 2008 and in 2009.
Also, the dollar rose in four of the five days of last week, helping to bump oil prices lower. On Friday, futures briefly fell below $100 per barrel for the first time since April.
Although crude prices softened last week, the dip in crude did not translate into lower gasoline prices. The shutdown of refineries in Texas ahead of Hurricane Ike’s landfall is leading to shortages of refined products – including gasoline.
Net for the week, spot prices for West Texas Intermediate dropped $5.05 per barrel to settle at $101.18 – and coming in $44.11 below the record settle of $145.29 per barrel set on July 3.
This past week, there were further signs of slowing in third quarter growth – with weakness showing up in a range of indicators, including retail sales and imports. And inventories are pointing to future weakness. However, lower gasoline and oil prices helped the latest inflation numbers come down.
 A clear sign of retrenchment by the consumer was a negative retail sales report for August. Retail sales fell for a second straight month, dropping 0.3 percent in August after a 0.5 percent fall in July.
Markets were surprised by the latest number as most expected strong auto sales to boost overall sales. While a 1.9 percent gain in motor vehicle sales was a positive (spurred by GM incentives), consumer spending was decidedly negative.
Excluding autos, sales plunged 0.7 percent, a very low reading for this category. August non-auto sales showed widespread declines in most categories, including electronics, building materials, general merchandise, non-store retailers, and gasoline stations. Gasoline sales dropped 2.5 percent, reflecting lower prices and soft demand.
Excluding both autos and gasoline, retail sales still were notably negative, falling 0.4 percent after rising by the same amount in July.
Overall retail sales on a year-on-year basis in August were up 1.6 percent – down from 2.1 percent in July. Excluding motor vehicles, the year-on-year gain came in at up 5.5 percent while excluding motor vehicles and gasoline, the year-ago increase stood at 5.9 percent.
The bottom line is that the consumer sector is running out of steam. Although gasoline prices have come down, they still remain high and are squeezing consumer budgets. Also, the spurt in unemployment has workers nervous about whether paychecks will be replaced with much lower unemployment benefits. The August retail sales numbers will see their next incarnation as part of personal consumption of durables and nondurables in the personal income report. On an inflation adjusted basis, the August spending numbers are likely to be dismal – adding to the argument that Q3 will be flat.
 The latest trade deficit numbers showed divergent trends – the most notable one is that consumer and business spending is slowing. The U.S. trade deficit in July widened sharply on a surge in oil imports but otherwise actually improved. The overall U.S. trade gap jumped to $62.2 billion from a revised $58.82 billion deficit in June. In July, exports advanced 3.3 percent while imports increased 3.9 percent.
But the overall worsening was due to a spike in oil prices as the oil gap gushed to $43.4 billion in July from $37.3 billion in June. The average price of imported oil set another record high, coming in at $124.66 per barrel in July, up from $117.13 per barrel in June. Spot prices peaked in early July and we are likely to see some easing in the monthly average for August.
Meanwhile the nonoil goods deficit narrowed to $29.6 billion from $32.5 billion in June. The nonoil deficit shrinkage largely was due to a decline in both capital goods and consumer goods imports, reflecting a slowing in the U.S. economy. Strength in exports was led by industrial supplies and automotive.
The good news from the July international trade report is that on an inflation adjusted basis, the export-import gap is likely to show significant improvement. This will be one of the likely few positive components in third quarter GDP. The bad news is that the slowing of imports for non-oil consumer goods and business equipment indicates a clear expectation of weak domestic demand in coming months.
 Unfortunately, the other likely “positive” contribution to third quarter GDP is inventories. The important fact about inventories is that often what is a positive for current quarter GDP is a negative for the outlook. A jump in inventories can be good if it is due to business expectations for a boost in demand but the jump is negative if due to a slump in demand. That second scenario now appears to be the case.
Retail inventories in July jumped 1.5 percent for the sharpest spike in more than two years, pushing the inventory-to-sales ratio 3 tenths higher to 1.48. Accumulation was concentrated in autos where inventories jumped 3.2 percent in the month. Inventories at furniture & electric rose 1.3 percent, building materials up 0.8 percent, apparel up 0.8 percent, and the expansive category of general merchandise up 0.3 percent. Based on the August retail sales report, some of the auto inventories have been sold off. But there likely will be more inventory problems in other parts of the economy.
 We got at least a temporary reprieve on the inflation front as the recent decline in crude oil prices filtered down to lower gasoline prices and even causing a drop in the headline PPI. Meanwhile, core inflation eased at least for now from heavy discounting by auto dealers. The overall PPI fell 0.9 percent, partially reversing July’s huge 1.2 percent spike. The core PPI rate eased to 0.2 percent, after jumping to 0.7 percent in July. The August core matched the market forecast for a 0.2 percent gain.
 As expected, energy pulled headline inflation down in August with a 4.6 percent drop after a 3.1 percent boost in July. Food price inflation was unchanged at 0.3 percent.
Indeed, the core was pushed down by discounting at auto dealers. Passenger cars slipped 0.3 percent while light trucks dropped 1.9 percent. Otherwise, core components were mixed.
While the August PPI report is welcome relief in the monthly direction of inflation, the bad news is that prices are still too high. For the overall PPI, the year-on-year rate came in at up 9.7 percent in August (seasonally adjusted) – barely lower than 9.8 percent in July. The core inflation remains elevated, rising to up 3.7 percent in August from up 3.6 percent the previous month. The upward trend in costs is still weighing on profits for many companies and is still pressuring companies to pass along costs when possible.
 The recent decline in oil prices pulled overall import prices down sharply in August. Import prices fell 3.7 percent in August, the largest single drop in 20 years, and followed a 0.2 percent rise in July. The year-on-year rate eased to 16.0 percent, coming off a record 21.7 percent in July.
Excluding a giant 12.8 percent monthly plunge in petroleum prices, import prices fell 0.3 percent but followed a string of rapid gains, including 0.7 percent and 0.8 percent increases in July and June, respectively. The year-on-year rate is still very high at up 7.5 percent – down from 7.8 percent in July.
The bottom line is the lower oil prices and slowing world demand are starting to help ease inflation. The big question mark is whether the easing in inflation will be enough without some help from the Fed and higher interest rates. For now, the Fed is betting on the slower economic growth doing the job.
 The impact of lower gasoline prices is spilling over into improved consumer sentiment. The Reuters/University of Michigan consumer sentiment index for August rose to at 73.1 from 63.0 in August for the biggest gain in nearly five years.
Both the current conditions and the expectations components showed improvement. The Expectations index jumped to 70.9 from 57.9 in August for the biggest monthly surge since the end of the 1991 recession. Improvement in current conditions was less dramatic, at 76.5 for a still sizable 5.5 point gain.
While the improvement in sentiment is welcome, levels remain rather low, indicating that consumers are still edgy about the economy.
On a final note, other good news in the sentiment report was a drop in inflation expectations, which fell 1.2 percentage points to 3.6 percent for the one-year outlook – another benefit from the decline in gasoline prices.
The markets fared quite well this past week considering that it could have been a nightmare had Fannie Mae and Freddie Mac not been “rescued” (even though stock holders of these GSEs are now holding essentially worthless paper – bond holders are still protected). Nonetheless, the economic trend is clear – slowing ahead. The biggest question is whether the markets and the Fed are accurately anticipating an expected moderate slowing in growth rather than an outright recession. The Treasury’s move last week at a minimum helped to reduce the odds of recession.
This coming week brings some heavy hitters for market moving indicators. Both manufacturing and housing sectors get updates with the industrial production and housing starts reports. We will see how lower oil prices are impacting the consumer sector with the CPI report. But the biggest story will likely come with Tuesday afternoon’s FOMC statement.
The Empire State manufacturing index edged back up into positive territory in August to 2.8 from minus 4.9 in July. Key readings were mostly near the neutral level of zero, indicating no growth but generally reflecting softer conditions than in July. Orders point to a sluggish overall number for September as new orders slipped to minus 2.2 from plus 8.3 in July. Also, unfilled orders slipped further – to minus 9.0 from minus 8.4 the month before.
Empire State Manufacturing Survey Consensus Forecast for September 08: 0.50
Range: -2.00 to 6.00
Industrial production in July posted a modest gain, led largely by a sizable gain in motor vehicles. Overall industrial production advanced 0.2 percent in July, following a 0.4 percent gain in June. The manufacturing component jumped 0.4 percent, after edging up 0.1 percent in June. Within manufacturing, gains were widespread but notable strength was in motor vehicles which increased 3.6 percent. Overall capacity utilization in July nudged up to 79.9 percent from 79.8 percent in June and compared to the market forecast for 79.8 percent in July. Looking ahead, the 0.8 percent drop in worker hours in manufacturing suggest a dip in manufacturing for August.
Industrial production Consensus Forecast for August: -0.3 percent
Range: -0.7 to 0.0 percent
Capacity utilization Consensus Forecast for August 08: 79.5 percent
Range: 79.2 to 79.7 percent
The consumer price index in July slowed at the headline level from a red hot June pace but still was very strong. The headline CPI posted a 0.8 percent boost in July, following a 1.1 percent spike the month before. As in recent months, energy led the boost in overall inflation with a monthly 4.0 percent rise, following a 6.6 percent increase in June. Food inflation continued to accelerate, rising 0.9 percent in July after a 0.8 percent jump in June. The core rate remained elevated with a 0.3 percent boost, matching June's gain. What's disconcerting is that gains were widespread except for medical care. But we are likely to get at least some temporary relief in August. Gasoline prices have come down and heavy discounting by auto dealers will even likely slow core inflation. Adding to the odds that we should get a more favorable CPI in August was the 3.7 percent drop in import prices for the same month – with consumer goods ex autos flat for the month.
CPI Consensus Forecast for August 08, m/m: -0.1 percent
Range: -0.3 to +0.8 percent
CPI Consensus Forecast for August 08, y/y: +5.4 percent
Range: +5.2 to +5.5 percent
CPI ex food & energy Consensus Forecast for August 08, m/m: +0.2 percent
Range: +0.1 to +0.3 percent
CPI ex food & energy Consensus Forecast for August 08, y/y: +2.6 percent
Range: +2.5 to +2.6 percent
The FOMC announcement for the September 16 FOMC policy meeting is expected to leave the fed funds target rate unchanged at 2 percent. But the announcement is likely to have market moving comments on the direction of Fed moves later this year and early next year. Although a few Fed regional bank presidents have been raising the decibel level about inflation warnings, others on the FOMC indicate that they are still concerned about market fragility. The recent takeover of Fannie Mae and Freddie Mac and Lehman Brothers’ thus far unsuccessful hunt for a buyer have been reminders to the Fed that the credit crisis is still weighing on the economy.
FOMC Consensus Forecast for 12/12/06 policy vote on fed funds target: unchanged at 2 percent
Range: 91 percent probability for no change and 9 percent probability for a 25 basis point cut, based on fed funds futures settle on September 12
Housing starts may return to a more normal pattern in August after heavy volatility in June and July. Starts in July fell sharply as expected after an artificial boost in the multifamily component in June. Starts fell 11.0 percent, following a 10.4 percent surge in June. But July's level in starts was a return to more normal conditions after a change in building code in New York City -- taking effect July 1 -- led to a run on both multifamily permits and multifamily starts to grandfather in the less restrictive code. The July pace of 0.965 million units annualized was down 29.6 percent year-on-year. Single-family starts in July continued their downward spiral, falling 2.9 percent after declining 3.2 percent in June. Unfortunately, there has been no change in the fundamentals to suggest a bottoming in starts yet. Unsold inventories of new and existing homes are still extremely high.
Housing starts Consensus Forecast for August 08: 0.950 million-unit rate
Range: 0.900 million to 1.000 million-unit rate
Initial jobless claims eased back by 6,000 in the week ending September 6 to 445,000, bumping the four-week average down slightly to 439,750. Nonetheless, the latest numbers still indicate a soft labor market. Initial claims are still under peaks of about 475,000 in the 2001 recession and 500,000 in the 1991 recession.
Jobless Claims Consensus Forecast for 9/13/08: 440,000
Range: 400,000 to 450,000
The Conference Board's index of leading indicators plunged 0.7 percent in July, skewed lower by a drop in building permits tied to one-time effects from New York City. But other components were lower as well including stock prices and jobless claims. However, the coincident indicator, closely watched for signals on recession, rose 0.1 percent in July following no change in June. This indicator suggests the economy continues to skirt recession.
Leading indicators Consensus Forecast for August 08: -0.2 percent
Range: -0.4 to 0.0 percent
The general business conditions component of the Philadelphia Fed's business outlook survey index improved in August – or more precisely – was less negative, rising to minus 12.7 from minus 16.3 in July. The general business conditions index has been negative for every month going back to December 2007. Looking ahead, the new orders index does not bode well. New orders remained on the decline, coming in at minus 11.9 – little changed from July's minus 12.1.
Philadelphia Fed survey Consensus Forecast for September 08: -10.3
Range: -12.0 to -9.2
Econoday Senior Writer Mark Pender contributed to this article.
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