The week's economic reports

Surprisingly strong retail sales (in part due to rising gasoline prices), sharply higher prices at the wholesale level (largely due to higher energy costs), and a narrowing of the trade gap during August (prior to the surge in oil prices), highlighted the week's economic data.

Stocks and bonds ended the week with the S&P 500 Index up 0.3 percent to 1,562, now up 10.1 percent for the year, and the yield of the 10-year U.S. Treasury note rose 3 basis points to 4.69 percent.
International Trade: The trade deficit narrowed from an upwardly revised $59.0 billion in July to $57.6 billion in August as a result of a 0.4 percent increase in exports and a 0.4 percent decline in imports. Exports have now risen for six consecutive months, aided by a falling U.S. dollar that makes U.S. goods and services less expensive around the world.

Net imports of oil from OPEC countries rose only slightly, from $24.0 billion in July to $24.3 billion, as crude oil prices rose modestly during the August reporting period (this report runs a month behind most others). With the average spot price of crude oil rising from the low $70 range in August to near $80 in September, look for increased oil imports again in the next report and possibly a bigger trade gap.

Retail Sales: Retail sales rose sharply in September, up 0.6 percent overall and 0.4 percent excluding motor vehicles, exceeding expectations and surprising many analysts after a number of relatively weak reports on chain store sales in recent weeks. This once again proves that the U.S. consumer is not dead yet, though the report is a bit deceiving in that a significant portion of the gains resulted from higher energy and food prices rather than the purchase of more goods. On a year-over-year basis, overall sales rose 5.0 percent and, excluding autos, slightly higher at 5.1 percent.
The monthly increase and the year-over-year gains were influenced greatly by rising gasoline prices. Sales at gasoline stations rose 2.0 percent in September and, if these sales are removed, demand at all other retailers increased by only 0.4 percent. On a year-over-year basis, gasoline station purchases rose a whopping 9.6 percent following the plunge in energy prices that began in August of 2006. Also from year-ago levels, food and beverage sales jumped 6.9 percent and health care spending rose 6.5 percent, all of this providing a good indication as to where an increasing amount of dollars are spent - on energy, food, and health care.

It is important to note that these figures are not adjusted for inflation - given rising prices (that do not necessarily show up in the consumer price index), higher retails sales do not necessarily indicate higher sales volume of goods.

With this better than expected report on September retail sales, the impact of personal spending on third quarter GDP is now anxiously awaited. Accounting for over 70 percent of economic activity, consumption is the key ingredient for continuing economic growth in the U.S. - the first look at third quarter real GDP will be released at the end of the month.

Producer Prices: In the first major indication of the impact that the late-Summer surge in crude oil prices will have on economic statistics in the period ahead, wholesale prices jumped 1.1 percent in September following a 1.4 percent decline in August. The sharp increase was led by a 4.1 percent surge in energy costs and a 1.5 percent rise in food prices. Excluding food and energy, producer prices rose 0.1 percent in September after a 0.2 percent gain in August.

On a year-over-year basis, the overall PPI is up 4.4 percent and the core rate stands at 2.0 percent. This is the highest annual rate since last summer when yearly increases of between four and six percent were common following the elevated energy prices that began when Hurricane Katrina struck the Gulf Coast in August of 2005. Next week's report on consumer prices should show a marked annual increase as well.

Consumer Sentiment: The Reuters/University of Michigan consumer sentiment index fell from 83.4 in September to 82.0 in the mid-October reading, making a new 13 month low. The final reading for October will be released in two weeks. High gas prices and the growing realization of trouble in housing and credit markets is taking its toll on the consumer outlook.

Summary: The strong retail sales report, though heavily influenced by higher gasoline station sales, is consistent with last week's reports on rising personal income and increased demand for revolving credit that have been supportive of consumer spending. However, this strength is at odds with recent reports from retailers where weakness has been the norm and price cuts for the holiday shopping season have already begun.

A better indication of the health of the consumer should be available with the first look at third quarter GDP later this month. As a result of the narrower trade gap and solid retail sales, estimates of real economic growth have been revised upward to the low three percent range just this past week, after many initial estimates had been below three percent.

As is usually the case when a new GDP number is about to be released, analysts begin looking toward the next quarter and, as a result of some of the delayed effects of the credit and housing market mess in combination with another anticipated pull-back by consumers, an increasing number of observers are now pointing to sharply lower growth for the fourth quarter.

Absent real distress in the labor market, consumers are likely to continue to spend, though not as freely as in prior years when the housing boom was at its peak. It is the job market that everyone is now watching for signs of trouble, however, given another drop in initial claims for unemployment insurance last week, steady job growth in non-farm payrolls after the revisions earlier this month, and the lack of anecdotal evidence that jobs are becoming more difficult to get, weakness in this sector has been slow to develop.

The Week Ahead: The week ahead will be highlighted by reports on consumer prices and housing starts, both on Wednesday. Also scheduled for release are industrial production and the home builders' housing market index on Tuesday, leading economic indicators on Thursday, and reports on New York and Philadelphia area manufacturing activity.