Saturday, August 16, 2008
Disappointing retail sales, a 17-year high in government reported inflation, and a narrowing trade deficit highlighted the week's economic reports.
Stocks and bonds ended with the S&P 500 Index up 0.2 percent to 1,298 (for a year-to-date total return of –10.5 percent) and the yield of the 10-year U.S. Treasury note fell 10 basis points to 3.84 percent.
International Trade: Rising exports caused the U.S. trade deficit to narrow in June to $56.8 billion following an upwardly revised deficit of $59.2 billion in May. The dollar amount of imported goods was $221.2 billion while exports totaled $164.4 billion with broad-based export gains led by capital goods. The cost of imported oil continued to rise, from $29.7 billion in May to $33.0 billion in June, however, this was largely due to a $10 average increase per barrel of oil as the number of barrels imported fell 7.5 percent from year ago levels.
Since the trade data lags most other economic reports by one month, this report still contains second quarter data which should help boost Gross Domestic Product when it is revised later this month. Some analysts have now raised their estimate of second quarter economic as high as 3.5 percent, up from the advance estimate of 1.9 percent announced last month. Rising exports (that could begin to reverse in the period ahead due to a stronger dollar) have been the primary driver of GDP growth in 2008, growth figures that would be negative without their support.
Retail Sales: The Commerce Department reported retail sales fell 0.1 percent in July, the first overall decline in five months, with the 2.4 percent plunge in automobile sales the primary reason for the poor performance.
Auto sales have now fallen 10.5 percent on a year-over-year basis, the steepest decline in almost six years, as consumers weigh the impact of higher gasoline costs and tighter credit during a period of uncertainty for the economy. Last month was the weakest month for Detroit motor vehicle sales in 16 years.
Excluding autos, retail sales rose 0.4 percent, also the worst reading since February, with most of this increase coming from higher gasoline station sales.
On a year-over-year basis, retail sales have now risen just 2.6 percent, a figure that is not adjusted for inflation, and, here too, the bulk of the gain can be attributed to rising fuel costs. Stripping out gasoline station sales, up 24 percent over the last year, retail sales show annual gains of just 0.2 percent.
Gasoline station sales rose 0.8 percent in July as the amount of fuel purchased (in volume terms) again declined, however, with prices now falling, this trend is likely to reverse next month.
The effects of $92 billion in government rebate checks have clearly worn off. This money was distributed mostly in May and June with a tiny portion sent out in July and most analysts believe that only about ten percent of this money went to discretionary purchases, the vast majority going to service existing debt or into savings.
Since personal consumption accounts for more than two-thirds of all U.S. economic activity, estimates for third quarter economic growth will likely be revised lower as forecasts for overall declines in consumer spending during the quarter are now being confirmed. Round two of the government stimulus effort should begin in earnest when Congress returns to Washington next month.
Consumer Prices: The Labor Department reported inflation is now rising at its fastest pace since 1991 - at year-over-year rate of 5.6 percent - as food and energy prices continue to surge.
Overall prices rose 0.8 percent in July after a gain of 1.1 percent in June marking the fastest three-month rate of price increases since late-2005 when Gulf Coast hurricanes sent energy prices soaring. The price gains from three years ago were quickly reversed as hurricane clean-up proceeded, however, there are fewer temporary factors at work today.
Monthly increases were paced by a 1.7 percent gain in transportation costs including fuel prices that rose 4.1 percent. Household energy costs rose 3.8 percent in July.
Prices for apparel rose 1.2 percent last month and are now up 0.8 percent from year ago levels. Falling prices for imported clothing have been a key factor in historically low inflation over the last ten years, however, this seems to be reversing now after an extended period of dollar weakness over the last few years.
Food prices continued their recent ascent, up 0.9 percent in July, after an increase of 0.3 percent in May and 0.7 percent in June. The cost of food has risen at an annualized rate of 7.6 percent over the last three months and 5.8 percent on a year-over-year basis.
The core rate of inflation, excluding food and energy, rose 0.3 percent and registered an annual increase of 2.5 percent. Food and energy prices are now up 15.5 percent from a year ago.
The recent decline in the price of crude oil should see energy prices dropping dramatically next month, putting downward pressure on the headline inflation figure, however, rising prices related to energy "pass-through" and the strength of the dollar are not likely to recede as quickly.
Consumer Sentiment: The mood of the consumer rose once again in the first of two readings for the month of August for the Reuters/University of Michigan consumer sentiment survey.
From 61.2 in July, the index rose to 61.7 in August, however, current readings are still very close to the half-century lows registered in June when gasoline prices were rising sharply.
In recent years, since the labor market has not been a major issue, there has been a very high correlation between the outlook of the consumer and the price of gasoline. With the pain at the pump easing in recent weeks, the August improvement makes sense.
The current conditions index fell 4 points to 69.3, however, the expectations index rose 3 points to 56.8, its highest level in five months.
Twelve month inflation expectations fell three tenths of a percentage point to 4.8 percent and the five year outlook was unchanged at 3.2 percent. This is the first time that inflation expectations have moderated since September of last year. The mood of the consumer is not nearly as bad as it was two months ago, but it is still very bad.
Summary: Rising exports and the narrowing of the trade deficit are certainly good news. This has been the most consistent positive story for the U.S. economy for many months now, but the strengthening dollar will surely begin to have a negative impact going forward. How long the dollar strength will last and how big an impact it will have on trade are anyone's guess.
Inflation surprised to the upside and retail sales were below expectations and, while both of these are long-developing stories, the former is expected to moderate in the months ahead as energy prices cool, but there is little long-term hope for improvement in the latter. If the speed at which the impact of the last economic stimulus faded is any indication, the American consumer is "tapped-out" with no ready cure available.
The mood of the consumer improved a bit but sentiment readings remain near historic lows with the grinding downward pull of a weak labor market perhaps about to replace the pain at the pump as the number one complaint in the period ahead. The labor market really is key at this point. Though somewhat distorted due to extended unemployment benefits, high readings for initial jobless claims in recent weeks are pointing to an even worse job market ahead.
The Week Ahead: The coming week will be highlighted by reports on housing starts and producer prices on Tuesday. Also scheduled for release are the housing market index on Monday and both leading economic indicators and the Philadelphia area manufacturing survey on Thursday.