The week's economic reports

Rising prices and sluggish income growth along with soaring initial jobless claims highlighted the week's economic reports. Stocks and bonds ended with the S&P 500 Index up 2.9 percent to 1,296 (for a year-to-date total return of –10.9 percent) and the yield of the 10-year U.S. Treasury note fell 3 basis points to 3.94 percent.
Personal Income/Spending: Aided by $28 billion in government stimulus checks, personal income rose just 0.1 percent in June after a downwardly revised surge of 1.8 percent in May when almost twice as much government money was distributed. Overall spending rose 0.6 percent in June after a gain of 0.8 percent in May led by a 1.3 percent increase in nondurable items, a category that was dominated by increased spending on gasoline. Amid an increasingly weak labor market and meager wage gains, the effects of the government stimulus money are quickly wearing off.

Rising inflation, the worst since Hurricane Katrina, was probably the most significant element of this report as the overall PCE price index posted a gain of 0.8 percent in June following an increase of 0.5 percent in May. On a year-over-year basis, overall inflation rose 4.1 percent, up from an annual rate of 3.5 percent the month prior.

ISM Nonmanufacturing Index: The overall ISM nonmanufacturing index rose modestly, from 48.2 in June to 49.5 in July, remaining below the 50 mark separating expansion from contraction for the fifth month in the last seven. In a bad sign for the second-half of the year (and consistent with last week's plunge in new orders for the ISM manufacturing index), new orders fell from 48.7 to 47.9, the lowest reading since January when the overall index registered just 41.9. Recall that this January reading of the ISM nonmanufacturing index shocked financial markets at the time.

Pending Home Sales: The number of existing homes entering the purchase contract stage during June rose 5.3 percent after a downwardly revised decline of 4.9 percent in May. One-third of all home resales are now distressed properties (either short sales or bank owned properties) and many of them are in former housing bubble hotspots such as Sacramento and Las Vegas where bargain hunters have seen prices fall precipitously. On a year-over-year basis, pending home sales are down 12.3 percent, a much more statistically important figure than the month-to-month change.

As discussed on many occasions over the last six months, while a bottom may be forming for home sales, it is home prices that are the key for the economy and home prices will continue to fall until the inventory overhang is reduced sharply or sales pick up dramatically. Current sales levels would have to double or inventory would have to be reduced by half to bring supply and demand back into balance.

Initial Jobless Claims: The Labor Department reported initial jobless claims rose by 7,000 last week, reaching a new high for the current cycle at 455,000, following the prior week's surge to 448,000.

These are the first back-to-back readings in the 450,000 range since April of 2003 and the highest single reading since March of 2002. The four-week average reached a five year high of 419,500.
Extended unemployment benefits, signed into law two months ago, have resulted in previously laid-off workers once again being eligible to apply for benefits and this is clearly helping to push recent claims higher. The Labor Department said it is not able to determine the extent of this impact but that it should fade over the next month.

Continuing claims rose 31,000 to 3.31 million during the week of July 26th (continuing claims lag initial claims by a week) reaching their highest level since October of 2003.

There is little good news coming from the labor market and it will likely get worse before it gets better as more lay-offs in the financial and construction industries along with state and local governments show up in the jobs data. More than a half million additional jobs are expected to be lost in the second half of the year and the unemployment rate is expected to soar next year to 6.5 percent.

Summary: Rising inflation, meager wage gains, and a weaker labor market were all on display again last week as good news is increasingly hard to come by - the prior week's stimulus-induced surge in real GDP and the welcomed narrowing of the trade gap due to rising exports just about sum up all the good economic news for the year so far.

Despite the eternal optimism of the National Association of Realtors, the housing market is getting worse, not better. This trend is likely to continue for some time to come despite upbeat projections on home sales which, even if they do materialize, will do little to stop home prices from falling unless foreclosures subside.

Next week's report on retails sales will shed more light on how the consumer is holding up and the latest inflation data may show energy prices peaking with other sectors just beginning to show the pass-through effects of higher oil prices.

The Week Ahead: The coming week will be highlighted by reports on retail sales on Wednesday and consumer prices on Thursday. Also scheduled for release are reports on international trade on Tuesday, import/export prices on Wednesday, and four reports on Friday - industrial production, consumer sentiment, international data flows, and the New York area manufacturing index.