The week's economic reports

Slowing growth in the manufacturing sector, tepid personal spending, and developing weakness in the labor market all added to the gloom that is descending over the economy and financial markets.

Stocks and bonds ended the week with the S&P 500 Index down 1.9 percent to 1,433, now up only 1.0 percent on the year, and the yield of the 10-year U.S. Treasury Note down 8 basis points to 4.70 percent.

Personal Income and Spending: Personal income rose 0.4 percent in June after the same size gain in May and is now up 6.1 percent on a year-over-year basis. Consumer spending rose a disappointing 0.1 percent in June after an upwardly revised increase of 0.6 percent in May and has gained 5.2 percent from year ago levels. Aided by falling gasoline prices, the PCE price index rose 0.1 percent in June after a 0.5 percent increase in May and the core PCE price index (excluding food and energy) rose 0.1 percent for the fourth consecutive month.

The annual revision to the Commerce Department data going back as far as 2004 resulted in a huge increase in income over that period wiping out all negative values previously reported for the personal saving rate. According to the revision, the "personal saving rate (personal saving as a percentage of DPI) was revised up from 2.0 percent to 2.1 percent for 2004, was revised up from negative 0.4 percent to positive 0.5 percent for 2005, and was revised up from negative 1.0 percent to positive 0.4 percent for 2006." For the month of June, the personal saving rate rose to 0.6 from 0.4 percent in May.

Chicago PMI: Consistent with the much broader ISM manufacturing index released on Wednesday, the Chicago purchasing managers' index plunged from 60.2 in June to 53.4 in July (readings above 50 indicate growth, readings below 50 indicate contraction). While this is indeed another piece of data pointing to cooling in the manufacturing sector, this report is much more volatile than the ISM index and advances and declines of this magnitude are commonplace for the Chicago PMI.

Construction Spending: Construction spending fell 0.3 percent in June after an upwardly revised gain of 1.1 percent in May. Once again, residential construction led the decline with a 0.7 percent drop. This was followed by a 0.6 percent decline in public outlays and a gain of 0.3 percent in private nonresidential construction.

Consumer Confidence: The Conference Board reported a large jump in consumer confidence in July to 112.6 following an upwardly revised reading of 105.3 in June. The upbeat mood was driven by the outlook for employment - those saying that jobs are "hard to get" fell from 20.5 percent in June to 18.4 percent in July and those saying that jobs are "plentiful" rose from 27.6 percent to 30.5 percent.

A roughly ten percent drop in the price of gasoline over the last two months helped to push confidence higher and inflation expectations lower. The twelve month inflation outlook fell from 5.4 percent to 5.1 percent, about two percentage points higher than the inflation expectations reported by the Reuters/University of Michigan consumer sentiment survey, however, both of these surveys are heavily influenced by the price of gasoline - if you want to know what consumers think about future inflation, just look at the recent trend in gasoline prices.

ISM Manufacturing: The ISM manufacturing index fell from 56.0 in June to 53.8 in July, still indicative of an expanding manufacturing sector, however, this could be the beginning of the end for the early-2007 surge in manufacturing. After bottoming out with two sub-50 readings around the first of the year, this latest reading marks a sharp reversal from earlier in the year when the index posted gains during four of the previous five months.

Production plunged from 62.9 in June to 55.6 in July and new orders fell from 60.3 to 57.5. Both of these readings continue to indicate expansion, but, given the recent weakness in auto sales, tepid consumer spending, and the beginning of a buildup in inventories, this may be a sign that the recent rebound in manufacturing has run its course.

The turnaround in the manufacturing sector has been much hailed as a sign that the economy was about to resume higher levels of economic growth later in 2007 after demonstrably weak growth was reported in late-2006 and early-2007. If the most recent trend continues, this will remove an important driver of the improved GDP growth as seen in the second quarter.

Pending Home Sales: The pending homes sales index rose a surprising 5.0 percent in June providing what is likely to be another false ray of hope for the nation's housing market. Cancellations are not included in this statistic and an increasing number of home sales that go under contract are falling apart due to tighter standards now being enforced by many lenders. It will not be known whether this uptick in sales is for real until the corresponding completed home sales are reported later this summer.

Employment Report: The labor department reported slowing job growth in July, down to a seasonally adjusted rate of 92,000 as employment gains in various service industries were offset by losses in manufacturing, construction, and government. The BLS (Bureau of Labor Statistics) data confirmed the slowdown reported in the ADP private payroll survey that showed an increase of just 48,000 new jobs.

Contrary to the pattern established over the last year, data for the two prior months were revised downward, falling from 190,000 to 188,000 in May and from 132,000 to 126,000 in June. On a year-over-year basis, the labor force gained 1.4 percent, matching the three-year lows of earlier this year.

The unemployment rated ticked up one-tenth of a percent to 4.6 and average hourly earnings increased 0.3 percent to $17.45, up 3.9 percent from year-ago levels, indicative of very little wage pressure. The generally good health of the labor market was echoed in yesterday's measure of consumer confidence where individuals continue to express little concern regarding the availability of jobs, however, the current trend in job growth points to trouble ahead.

By major category, growth was once again led by education and health care services, however, the financial activities category posted solid gains led by an 11,000 gain in credit intermediation and related activities, perhaps a byproduct of the increasing tumult in credit markets and the related home foreclosures and bankruptcies. Computer systems design in the professional and business services category posted an impressive gain of 14,800 positions and the always reliable restaurant and bar employment in the leisure and hospitality category added 22,200 new spots.

Declines in construction employment were dispersed between residential and nonresidential building with, surprisingly, nonresidential work declining more than residential work. A total of 1,600 residential construction jobs were lost while employment related to public and government buildings declined by 8,200.

As an indication that the home improvement boom has not completely stopped, residential specialty trade contractors gained 2,600 positions while homebuilders let go 4,200 workers, however, as has been the case over the last year or so, there are an unknown number of illegal workers that do now show up in the BLS data who are now out looking for work.

ISM Non-Manufacturing Index: Like the ISM manufacturing survey released on Wednesday, the ISM non-manufacturing index fell sharply in July after rising earlier in the year. The non-manufacturing index fell from 60.7 in June to 55.8 in July paced by declines in new orders and employment while inventories increased here as well.

Summary: As discussed in this section last week and confirmed in the most recent data, manufacturing activity shows signs of having peaked over the last month or so leading to what may be a reversal of one important trend that supported economic growth during the second quarter. Recall that second quarter real economic growth came in at 3.4 percent last week following four quarters where growth averaged only 1.5 percent.

Employment also seems to be softening as evidenced by one of the weakest totals for new jobs in almost three years. With dismal auto sales, a decline in consumer spending, and no end in sight for an increasingly troubled housing market, all of this points to slower economic growth in the third quarter. Last week's advance estimate of second quarter growth will be followed by the preliminary Q2 estimate later this month, then the final Q2 reading at the end of September. The first look at third quarter GDP will not occur until the end of October - it is anyone's guess what the condition of credit and asset markets will be at that time.

The Week Ahead: Economic reports in the week ahead will be highlighted by the Federal Open Market Committee policy meeting on Tuesday. Other than that, there will be few reports of note - productivity and costs along with consumer sentiment on Tuesday and import/export prices on Friday.