The markets lost ground this week, dropping on Tuesday and Wednesday with a rally on Friday that erased some of the losses from earlier in the week. Earlier in the week, big deals led to some optimism, as Oracle announced it was buy Seibel Systems and Ebay announced it was buying an internet phone company. Later in the week, concerns about the consumer's financial health and higher oil prices led to declines. In short, the market was caught between divergent economic perspectives, with some bullish on a Katrina led 2006 recovery and others concerned about consumer spending and oil's continued impact on the economy.
The bond market spent the week trying to get a solid read on next week's Fed meeting and inflation. Before Katrina, traders were convinced the Fed would increase interest rates 25 basis points at next week's meeting. After Katrina hit, traders speculated the Fed would pause, largely out of political expediency. However, the prices paid index of the two manufacturing reports issued this week (see below) and Bush's spending proposal for Katrina led to a three-day sell-off starting on Wednesday. In short, it appears traders are concerned about inflation as well as the increased government spending associated with Katrina.
Currently, the oil markets are caught in the cross-current of several competing economic trends. The bears are focused on the negative impact higher prices are having on global economic growth. OPEC, the Department of Energy and the International Energy Association have all lowered their demand projections for oil, largely based on oil's high price. Bulls are focused on gulf production, which is still down and won't be fully restored for some time - maybe next year. This is leading to concern about price spikes in distillates - products made from crude oil. These competing market perceptions are looking for a new equilibrium price in the oil markets. $63 to $65-50 appears to be the new trading range. Technically, the long-term charts are now nearing oversold, indicating an upward spike is more likely next week.
As with the bond market, the dollar spent the week trying to get an idea on the Fed's interest rate policy. For the last year, the forex markets have traded based on the respective growth rates of host economies and the interest rate differentials between global economies. As a result, the dollar has gained versus the yen and the euro. That trend continued this week with the dollar rising versus the yen and the euro as currency traders bet the Fed would continue its pace of rate increases. In addition, currency traders rewarded the dollar with the better-than-expected current account news on Tuesday and Friday.
Tuesday: Trade Deficit
The Nation's international deficit in goods and services decreased to $57.9 billion in July from $59.5 billion (revised) in June, as exports increased and imports decreased.
Exports increased to $106.2 billion in July from $105.8 billion in June. Goods were $74.9 billion in July, up from $74.5 billion in June. Services were virtually unchanged at $31.3 billion in July.
Imports decreased to $164.2 billion in July from $165.3 billion in June. Goods were $137.5 billion in July, down from $138.3 billion in June, and services were $26.7 billion in July, down from $27.0 billion in June.
For goods, the deficit was $62.6 billion in July, down from $63.8 billion in June. For services, the surplus was $4.6 billion in July, up from $4.3 billion in June.
The government revised the June number upwards from 58.5 to 59.3 billion. The consensus estimate was 59.8 billion, so this number came in better than expected. This number means the US will still have to import 1.9 billion a day in foreign capital to maintain its standard of living.
This number has only gotten worse for the last few years. It started to precipitously drop at the end of 2001 when the monthly average was just under 30 billion to the current monthly totals of between 55-60 billion. When the dollar dropped last year, the trade deficit still expanded. This implies the dollar will have to drop further than previous lows before the lost value will translate into a material advantage in trade.
There is also a fair amount of commentary stating Katrina will have a negative impact on the trade deficit. The US will have to import more to rebuild the affected areas and will probably export less because of the ports affected.
Tuesday: Producer Prices
The Producer Price Index for Finished Goods rose 0.6 percent in August, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. This increase followed a 1.0-percent gain in July and no change in June. At the earlier stages of processing, prices received by manufacturers of intermediate goods advanced 0.7 percent, after moving up 1.0 percent in the preceding month. The crude goods index climbed 2.3 percent in August, following a 6.7-percent rise in July.
The "core number" -- which does not include food and energy - was 0.0.
Energy is a big concern in the economy right now. At the beginning of the year, economists reported that businesses were absorbing increased energy prices and not passing them onto the consumer. These reports have changed over the last few months, with indications businesses have regained some pricing power and are therefore adding some energy costs into goods' prices. However, there are also reports stating energy prices are beginning to slow the economy. This indicates the period of passing on increased fuel prices may be coming to an end. This scenario places the Fed in a very difficult and unenviable policy position.
Wednesday: Retail Sales
The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for August, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $350.1 billion, a decrease of 2.1 percent (±0.7%) from the previous month, but up 7.9 percent (±0.8%) from August 2004. Total sales for the June through August 2005 period were up 9.4 percent (±0.5%) from the same period a year ago. The June to July 2005 percent change was unrevised from +1.8 percent (±0.3%).
The main of concern in this report was the drop in auto sales, which dropped 12%. Part of this may be the result of "employee discount pricing" losing its appeal. This promotion has been going on for a few months, and it is possible the car market is literally saturated with product. However, it could also indicate some consumer's lowering their spending. This is just a hunch; there is no way to tell directly from this particular data. However, the second largest increase in retail sales, which increased 4.4% from July. This increase may have tightened their budget just enough to force them to cut back on autos purchases.
Thursday: Consumer Price Index
On a seasonally adjusted basis, the CPI-U increased 0.5 percent in August, the same as in July. Energy costs increased sharply for the second consecutive month--up 5.0 percent in August. Within energy, the index for energy commodities (petroleum-based energy) increased 7.9 percent and the index for energy services rose 1.3 percent. The index for food was unchanged in August, as a 0.3 percent increase in the index for food away from home offset a 0.2 percent decline in the index for food at home. The index for all items less food and energy registered a 0.1 percent increase for the fourth consecutive month. Shelter costs, which rose 0.3 percent in July, were virtually unchanged in August, reflecting a downturn in the index for lodging away from home. This deceleration was largely offset by an upturn in the index for apparel.
Thus number came in line with expectations. There has been a great deal of debate in the financial press and market reports about the Fed's actions at its meeting next week. This report - combined with the regional manufacturing survey's (see below) -- indicate high energy prices are starting to increase other prices in the economy. As a result, an interest rate increase at the next meeting is a high probability.
Thursday: Philly Fed Survey
The survey's broadest measure of manufacturing conditions, the diffusion index of current activity, fell from 17.5 to 2.2, the lowest reading in three months. Fifty-seven percent of the firms reported higher input prices, compared to 33 percent in August. The prices paid index rose 27 points to its highest reading since January. The future general activity index fell from 33.4 in August to 7.0 this month, the lowest reading since January 2001."
The prices paid index is particularly important. It indicates energy price increases as a result of Katrina's effect on the gulf are starting to filter through the economy. Although they have not shown-up in consumer prices outside of direct products (such as gas), producers will eventually have to pass-on these price increases to recoup their cost and still make a profit.
Thursday: Empire State Index
The bank's Empire State Manufacturing index fell to 17.0 in September from 23.0 in August.
Readings over zero indicate expansion.
The decline was roughly in line with expectations. Economists were expecting the index to slip to 16.6.
The biggest impact of Katrina came in the form of higher prices. The price index jumped more than 20 points to 53.4 in September, its highest level since March.
Expectations of price increases over the next six months also jumped to record highs.
As with the Philly Index, the prices paid component to the NY index rose sharply. See the above comments.
Friday: Consumer Sentiment.
The University of Michigan's preliminary index of consumer sentiment fell to 76.9 this month from 89.1 in August, surpassing even the drop following the 2001 terror attacks as the biggest decline since December 1980.
``These are abysmal numbers, suggesting a deeply pessimistic consumer in the first half of September,'' when gasoline prices peaked and officials were predicting as many as 10,000 deaths, said Christopher Low, chief economist at FTN Financial in New York. ``Things still appear grim, but are not nearly as bad as that. We look for some recovery in confidence as early as the final September report.''
Although this is a record drop, it's very important to remember it is a single month. Should the reconstruction efforts go well and gas prices fall, the number could easily rebound. What will be important is if the number continues its move downward or remains at these levels when the survey is reported next. In other words, we have to see if this is a beginning of a trend downward, or a one-time blip caused by a natural disaster.
Friday: International Transactions
The U.S. current-account deficit--the combined balances on trade in goods and services, income, and net unilateral current transfers--decreased to $195.7 billion in the second quarter of 2005 (preliminary) from $198.7 billion(revised) in the first quarter. The decrease was more than accounted for by a decrease in net outflows for unilateral current transfers. A small increase in the surplus on services also contributed. In contrast, the balance on income shifted to a deficit from a surplus, and the deficit on goods increased.
Capital account transactions were net outflows of $0.3 billion in the second quarter, down from net outflows of $4.5 billion in the first.
The primary reason for the drop was the figure quoted in the second paragraph, the drop in net financial outflows. The goods deficit remained essentially stagnant with exports increasing 9.7 billion but import increasing a little over 10 billion. The services balance - which is positive for the US - increased .3 billion. Income payment increases on assets outside the US more-or-less equaled income payments increases from within the US. In other words, the quarterly trade data generally showed more of the same.