The week's economic reports

Following is a summary of last week's economic reports. The ISM services index rose sharply while productivity was revised downward and consumer credit slowed, all of this painting a mixed picture of the economy during a light week of reporting. Stocks and bonds ended the week with the S&P 500 Index down 1.9 percent to 1508, now up 6.3 percent on the year, and the yield of the 10-year U.S. Treasury up 16 basis points to 5.12 percent.


Factory Orders: Factory orders came in below expectations at 0.3 percent in April after a very strong, upwardly revised gain of 4.1 percent in March. Orders for metal products, electrical equipment, and computers increased while orders for transportation equipment and construction machinery declined.

ISM Non-Manufacturing Index: The Institute for Supply Management reported that services activity nationwide rose sharply, from 56.0 in April to 59.7 in May, to the highest level in more than a year. Strength was seen in new orders, export orders, and employment with only modest gains in prices paid. Inventories increased dramatically, from 52.0 in April to 61.0 in May, perhaps an indication of an early "inventory build" in anticipation of higher levels of demand.

After bottoming in March at 52.5, this index has seen its strongest two-month advance since early-2003, near the bottom of the last downturn. It remains to be seen whether the last two months are the beginning of broader strength in the service sector or if it was simply a bounce back from the March lows, which were, coincidentally, at levels not seen since early-2003.

Productivity and Costs: Nonfarm productivity for the first quarter was revised downward from an annualized rate of 1.7 percent to 1.0 percent. On a year-over-year basis, productivity showed a gain of 1.0 percent, down from the 1.6 percent rate of the fourth quarter, but close to the 0.8 percent pace of the third quarter of 2006 which was one the lowest levels recorded over the last decade.

Unit labor costs were revised sharply upward, from an annualized rate of 0.6 percent to 1.8 percent, however this increase pales in comparison to the increase in labor costs during the fourth quarter at a shocking 8.9 percent.

Consumer Credit: New debt taken on by consumers slowed dramatically in April to $2.6 billion after a $13.5 billion increase in March. Revolving credit (e.g. credit cards) fell $0.4 billion and non-revolving credit (e.g., auto loans) rose $3.0 billion.

The reduction in revolving credit was inconsistent with the trend of the last eighteen months, in fact, the April decline was the first decline since early 2006 when consumers began relying less on mortgage equity withdrawal, amid a slumping housing market, turning instead to credit cards. The slowdown in consumer borrowing is consistent with reports of weaker retail and same store sales as gas prices near all-time highs continue to curtail discretionary spending.

International Trade: The trade deficit narrowed much more than expected, falling from $63.9 billion in March to $58.5 billion in April. The improvement was driven by declining imports (down 1.9 percent) which, when combined with an increase in exports (up 0.2 percent), narrowed the gap. The reduced level of imports was driven by fewer consumer goods and automobiles while oil imports fell only marginally.

The politically sensitive trade gap with China widened once again, from $17.2 billion in March to $19.4 billion in April and with Europe, the deficit increased from $7.7 billion to $9.0 billion. Through the first four months of this year, the deficit is running at an annual rate of $706 billion, a 7 percent decline from last year's record $759 billion imbalance.

Summary: The better than expected ISM non-manufacturing survey added to the case for a nascent economic recovery, but as mentioned here last week, the "elephant in the living room" for the U.S. economy is consumer spending and it increasingly appears as though the consumer is in for a long and drawn-out retrenchment that will eventually affect the rest of the economy in a material way.

The disappointing same store sales reported on Wednesday, where luxury retailers fared well and Wal-Mart struggled, follows recently sluggish overall retail sales reports during the spring. Combined with reduced mortgage equity withdrawal, persistently high energy costs, and higher interest rates that may eliminate any hope of a housing rebound this year, the long-awaited consumer spending slowdown may soon be here.

Of course it is important to remember that the American consumer has been counted out nearly every year since the housing boom began earlier this decade.

The Week Ahead: Economic reports in the week ahead will be highlighted by retail sales on Wednesday, producer prices on Thursday, and consumer prices on Friday. Also scheduled for release are import/export prices and business inventories on Wednesday and three reports on Friday - industrial production, consumer sentiment, and the New York area manufacturing survey.