The week's economic reports

A deteriorating housing market and a sagging consumer sector point to a weaker economy ahead - with only moderate inflation, this should pave the way for the Federal Reserve to cut the Fed Funds rate in the weeks ahead if necessary. Stocks and bonds ended the week with the S&P 500 Index down 0.5 percent to 1,446, now down 0.5 percent on the year, and the yield of the 10-year U.S. Treasury note down 11 basis points to 4.67 percent.

Retail Sales: Retail sales rebounded in July, rising 0.3 percent after an upwardly revised decline of 0.7 percent in June. Excluding auto sales, retail sales rose 0.4 percent after an upwardly revised decline of 0.2 percent the month prior. On a year-over-year basis, overall retail sales were up 3.2 percent and, excluding auto sales, the yearly gain was 4.4 percent.

Much of the overall increase in July came from moderating gasoline prices and, since prices at the pump have continued to fall after the cut-off date for the July report, lower gas costs could aid August retail sales as well. Sales gains were led by clothing (up 1.3 percent), electronics (up 1.0 percent), general merchandise (up 0.9 percent), and home furnishings (up 0.8 percent) - even the beleaguered building material store sales rose in July (up 0.2 percent). Note that the increase in clothing costs also showed up in the consumer price index last week, part of the relatively new "exporting of inflation" from China.

The long-term picture remains unchanged with the most recent data - consumer spending has been on a downward path for almost two years now and may accelerate to the downside with continuing fallout from the real estate market and a diminishing wealth effect.

International Trade: The U.S. trade gap with the rest of the world narrowed from $59.2 billion in May to $58.1 billion in June, the improvement driven by higher exports in combination with only a moderate increase in the price of imported crude oil. Note that the international trade report is a month behind most other reports and, as a result, the recent surge in oil prices last month will not show up until the July data is reported in September.

Producer Prices: Higher energy costs pushed wholesale prices higher as the producer price index gained 0.6 percent in July after a decline of 0.2 percent in June. Excluding food and energy, prices rose 0.1 percent in July after gaining 0.3 percent the month prior. On a year-over-year basis, overall prices are up 3.9 percent and the core rate stands at 2.4 percent. Energy prices rose 2.5 percent in July, paced by a 3.2 percent gain in the price of gasoline and a 2.7 percent increase in residential natural gas. Food prices fell 0.1 percent after a 0.8 percent decline in June.

Consumer Prices: The Bureau of Labor Statistics reported moderate increases in consumer prices for July, overall inflation rising 0.1 percent after a 0.2 percent increase in June. Core inflation, excluding food and energy, rose 0.2 percent in July, the same as in June and, on a year-over-year basis, overall inflation was up 2.4 percent while core inflation rose 2.2 percent.

Energy prices declined 1.0 percent during July, led by gasoline prices that fell 1.7 percent and food prices dropped 0.3 percent. Medical care costs rose 0.6 percent and prices for apparel gained 0.4 percent, another indication that China no longer exports as much "deflation" as they once did - for years, apparel prices did nothing but go down.

For an interesting look at how the year-over-year inflation statistics will be affected by last year's plunging energy prices in the months ahead, have a look at this item posted here last week Ben, if you're going to cut rates...

Housing Market Index: The National Association of Home Builders Housing Market Index dropped another two points in August to a 16-year low of 22. The buyer traffic component saw a steep decline of 16 percent, another indication of just how hard it might be to turn the tide of public opinion for a real estate market where buyers have become increasingly skittish.

NY Empire State Index/Philadelphia Fed Survey: The New York and Philadelphia area manufacturing indexes went in opposite directions during August, the former posting a third strong month in the mid-20s while the latter came in at exactly zero, indicating no increase in business activity. These are volatile indexes and the next national ISM manufacturing survey scheduled for release during the first week in September will provide a better indication as to whether the early-2007 manufacturing rebound still has legs or if it was merely a short-lived rebound from multi-year lows at the beginning of the year.

Housing Starts: New home construction plumbed even lower lows in July, housing starts falling 6.1 percent to a seasonally adjusted annualized rate of 1.381 million following last month's 2.1 percent increase. This marks the lowest number of new home starts in 10 years. Permits for new construction dropped 2.8 percent to an annual rate of 1.373 million units, following June's total of 1.413 million. The June data for both housing starts and permits were revised up slightly, a break from the pattern established over the last year or so.

Just as current foreclosure statistics sound worse than they really are on a per capita basis when compared to historical data, the ten-year low in housing starts really is worse than reported because the statistics are not adjusted for the growth in the population - this level of homebuilding, given the increase in population over the last decade, is much worse than the same level back in 1997.

Despite many calls for a bottom after each uptick over the last year, credit tightening and growing inventory have led to even further deterioration in the homebuilding industry. With growing inventory from foreclosures now hitting the market and the beginning of price capitulation for "bank owned real estate", there seems to be little hope for any sort of rebound in homebuilding anytime soon.

Consumer Sentiment: Much was made of last month's rebound in the Reuters/University of Michigan consumer sentiment index where, after declining four out of the previous five months, confidence rebounded strongly. After a July reading of 92.4, sentiment plunged to 83.3, the lowest level in a year, as the combination of declining home prices and tumult in financial markets appear to have offset the respite that falling gasoline prices provided. This latest reading will surely add to the calls for the Fed to cut short-term interest rates - a dour consumer leads to a dour economy, unfortunately.

Summary: During the month of July, consumer prices rose modestly, as expected, and wholesale prices were only somewhat elevated, paving the way for the Federal Reserve to cut interest rates if they so choose - the Fed should be able to lower the Fed Funds rate in the weeks ahead or at the September 18th FOMC meeting and still claim that inflation is under control.

Home construction and builder confidence that continued to plumb new multi-decade lows, plunging consumer confidence, and tepid growth in retail sales all strengthened the case for weaker consumer spending for the rest of the year. On the bright side, industrial production rose and the trade deficit narrowed while manufacturing activity in the Northeast was mixed - up in New York and flat in Philadelphia.

The Week Ahead: After a bevy of reports last week, next week will be light on economic data - leading economic indicators on Monday and both durable goods orders and new home sales on Friday.