Weekly Economic Commentary

Vacation Week Fireworks?

Although many market participants are likely to be away from the office this week, they risk missing a busy week for economic data, which is sandwiched between a policy-heavy June 2012 and the unofficial start of the corporate earnings reporting season on July 9. As this publication was being prepared, markets have already digested several key economic reports, including:

·         China’s Purchasing Managers’ Index (PMI) for June 2012, which was better than expected, but still suggested that the Chinese economy continued to slow as the first half ended,

·         Japan’s Tankan Index for the second quarter 2012 also surpassed lowered expectations, but suggested little, if any growth in the Japanese manufacturing economy,

·         India’s PMI for June 2012 also surpassed lowered expectations and was stronger than the May 2012 reading. The report suggested that Asia’s third-largest economy may be responding to rate cuts engineered by India’s central bank in spring 2012,

·         Brazil’s industrial production for May 2012,

·         Eurozone PMI for June 2012,

·         Eurozone employment for May 2012, and

·         The U.S. Institute for Supply Management (ISM) report for June 2012.

With one important exception — the U.S. ISM report for June, which came in lower than expected, below the low end of the range of expectations, and below 50 (indicating that the manufacturing sector contracted in June) — this round of important data came in above sharply lowered expectations. With the Eurozone fiscal and financial woes likely to be on the back burner for a while, the pace of economic growth in Europe, the United States, and especially China will likely move to the front burner.

 China Economy Fizzling

Although several other reports on China’s economy in June 2012 are due out this week, including the service sector PMI for June 2012, the next round of data (money supply, retail sales, industrial production, new loan growth, exports and imports, etc.) on the Chinese economy is not due until next week (July 9 – 13). Our view remains that the Chinese economy will avoid a “hard landing” (5 – 6% real gross domestic product [GDP] growth), and that further fiscal and monetary policy stimulus is likely from Chinese authorities in the weeks and months ahead. Until then, fretting over the health of the Chinese economy could replace the uncertainty surrounding recent major policy events as the market’s favorite summer pastime.

Potential Oohs and Ahhs on European Monetary Front

The unexpected agreement reached late last week (June 25 – 29) at the Eurozone leaders’ summit has, for now, pushed market concerns over Europe to the back burner. That does not mean, however, that markets will not be paying attention to several key policy-related events in Europe this week. On Tuesday, July 3, the new French government under François Hollande will present its budget plan for the coming year, and this may briefly refocus the market’s attention on European fiscal woes. The markets are looking for a mix of short-term growth measures combined with a commitment to lower France’s debt level over the longer term. Later in the week, German Chancellor Angela Merkel will meet with her Italian counterpart Mario Monti. The pair has plenty to discuss aside from the latest soccer scores. Although the market is not expecting anything concrete from this meeting, market participants would welcome signs that Europe is cooperating and moving closer together.

Fiscal policy has been in the driver’s seat in Europe recently, but that may change this week, as the Bank of England (BOE) and the European Central Bank (ECB) meet to discuss monetary policy. On the heels of the political/ fiscal progress made at the Eurozone leaders’ summit in Brussels last week, the outcome of the French and Greek elections in mid-June, as well as the Fed’s decision in mid-June to extend Operation Twist to the end of 2012, both the ECB and BOE are expected to act this week. The market expects a rate cut from the ECB, and perhaps even a promise to do more. In the U.K., the market now expects another round of quantitative easing from the BOE, as the U.K. is teetering on the edge of recession amid the economic and fiscal uncertainty from the neighboring Eurozone. Central banks in Sweden, Poland, Russia, and Australia also meet this week, but markets do not expect any of these banks to act in a similar fashion as the BOE and ECB.

Grand Finale: U.S. Jobs Report

The grand finale of the week, of course, will be the release of the June employment report for the United States on Friday, July 6. As we have noted in prior Weekly Economic Commentaries, the monthly jobs report has implications for the overall economy, the Fed, and the upcoming U.S. presidential elections. We will focus on the jobs report’s impact on the overall economy and the Fed this week, but please see the Weekly Economic Commentary from May 29, 2012, for a look at how the unemployment rate has impacted the outcome of the presidential election in prior years.

A well-documented warmer-than-usual winter in 2011 – 12 led to the monthly count of private sector jobs exceeding economists’ estimates from December 2011 through February 2012. Since then, the market has overestimated the number of jobs created, as the number of private sector jobs created from March through May 2012 fell far short of expectations. As this publication was being prepared, the consensus was looking for a 100,000 gain in private sector employment in June 2012, an improvement on the 82,000 jobs created in May 2012, but still the lowest estimate for the report since economists were looking for 90,000 jobs to be created in September 2011. The most optimistic forecaster is looking for 175,000 private sector jobs to be created in June, while the low end of the range is at 45,000. The last time the low end of the range of estimates for the monthly jobs report was this low was back in August 2011. As market participants prepare for the report, they are asking: Have estimates fallen far enough? If they have not fallen enough, markets may see fireworks on both July 4 and July 6 this year.

The forecast for a 100,000 increase in private sector jobs in June 2012 pales in comparison to the weather-boosted 250,000 jobs per month created in December 2011, January 2012, and February 2012. Last fall, prior to the warmer weather, the economy was creating around 150,000 jobs per month. The true pace of underlying job growth is likely somewhere between 150,000 and 250,000.

Compared with last fall, when the level of initial claims for unemployment insurance was running over 400,000 per week, the level of initial claims filed each week in June 2012 (around 390,000 per week) suggests that hiring is a bit more robust today. Several other indicators suggest that the economy is probably creating more jobs than it was last fall (150,000 per month), but not many more:

·         The increase in consumer sentiment,

·         The near-record level of corporate profits and cash flows,

·         The increase in job openings, and

·         The number of job quitters as a percent of overall job separations.

Policymakers at the Federal Reserve (Fed) also will likely have a keen interest in the June jobs report, as they continue to mull the possibility of more monetary policy stimulus. The labor market and, in particular, the unemployment rate, will likely be a key determinate for the Fed. The Fed now expects the unemployment rate to average 8.1% in the fourth quarter of 2012. The median forecast for the June 2012 unemployment rate is 8.2%, and the economy probably needs to create around 100,000 jobs per month just to keep the unemployment rate steady.

In the press conference following the June 20 Federal Open Market Committee (FOMC) meeting, Fed Chairman Ben Bernanke said that if the Fed does not see improvement in the labor market, the Fed will take additional steps to stimulate the economy. In his April 2012 post-FOMC press conference, Bernanke said, “we’ll continue to be watching the labor market. That’s a very important consideration. If unemployment looks like it’s no longer making progress, that’ll be an important consideration in thinking about policy options.” Thus, another weak employment report in June may prompt Fed officials to think about another round of monetary stimulus (round three of quantitative easing, known as QE3), which may cause some political fireworks later this year.

Prepared by:

John Canally, CFA

Economist LPL Financial

_________________________________________________________

IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Chinese Purchasing Managers Index: The PMI includes a package of indices to measure manufacturing sector performance. A reading above 50 percent indicates economic expansion, while that below 50 percent indicates contraction.

The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

The Bank of Japan produces a quarterly “Tankan” survey of corporations that provides insight into the current business climate in Japan. The Bank of Japan uses this survey to help determine monetary policy.

The Eurozone Purchasing Managers’ Index (PMI) assesses business conditions in the manufacturing sector.

International investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nation’s open market operations (i.e., the Fed’s buying and selling of United States Treasure securities).

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Member FINRA/SIPC

Tracking #1-080674 (Exp. 07/13)

Weekly Economic Commentary

Fed FAQ: Fanning the FOMC Flames

What Are the Fed’s Options at This Week’s FOMC Meeting?

This week’s meeting of the Federal Open Market Committee (FOMC) is the fourth of eight such meetings this year. Along with releasing a decision on monetary policy at 12:30 PM ET on Wednesday, June 20, the Federal Reserve’s (Fed) policymaking arm will also release its latest forecast of the economy, the labor market, and inflation at 2:00 PM ET on June 20, followed shortly by a press conference with Fed Chairman Ben Bernanke.

The market now expects some action from the Fed at this meeting. If the Fed does nothing — lets Operation Twist end as planned on June, 30, 2012 without replacing it with something else — markets will likely be disappointed.

Extending the commitment to keep the Fed funds rate near zero beyond the end of 2014 is the minimum the Fed could do to keep markets placated. The Fed first announced its commitment to keep rates near zero in August 2011, at the time, committing to keep rates near zero until mid-2013. In January 2012, the Fed extended its promise to keep rates at exceptionally low levels until late 2014. Still, the markets would, at least initially, view a change in the Fed’s commitment to keep rates on hold as a disappointment relative to current market expectations.

If the Fed does nothing, but hints (either in the statement or via comments made by Bernanke) that further action may come as soon as the August 1, 2012 FOMC meeting, the markets would still likely be disappointed. The markets' focus then would shift to Bernanke’s press conference and back to the Fed’s new economic forecast, as participants try to gauge the timing of the next round of stimulus.

Most market participants now expect the Fed to renew Operation Twist. Twist involved the Fed selling some of its shorter-dated Treasury holdings and purchasing longer-dated Treasuries in the open market in order to keep long-term Treasury yields lower for longer. When it was first announced in September 2011, Operation Twist promised to purchase $400 billion in Treasuries by the end of June 2012. If the Fed decides to extend the program, the size and timing will be important. Will the Fed announce the size and the timing, or will it decline to pre-commit to a full dollar amount or a specified timeline? Markets like clarity, so the more specifics the Fed can provide around extending Operation Twist, the better for the markets.

An announcement that extends Operation Twist and hints that the Fed is prepared to take additional action quickly would likely be viewed more positively by markets than just extending Operation Twist beyond the end of June 2012. The more specific the Fed is in any kind of conditional promise to “do more” (extend Operation Twist, increase the size of its balance sheet, or some other kind of stimulus), the better it would be received by financial market participants. Specifics might include trigger points around inflation, economic growth, the labor market, and possibly even on the situation in Europe. In our view, however, there is a low probability that the Fed would get this specific.

Although a few market participants expect the Fed to announce another expansion of its balance sheet, which would represent the third round of quantitative easing (QE3) by the Fed since the fall of 2008, this type of announcement would likely be viewed highly favorably by markets. The Fed could choose to purchase more Treasuries, mortgage backed securities (MBS), or both. As with extending Twist, the more specifics (on size and timing of the planned purchases), the more the markets will embrace the operation. The goal of QE3 would be to keep rates most used to set loans for consumers, homebuyers, and businesses lower for longer. In this scenario, the Fed could choose to make the purchases outright (as they did in QE1 and QE2) or sterilize the purchases. This means that the Fed would immediately borrow back some of the cash it injects into the financial system as it purchases the securities in the open market. For our analysis of what sterilized QE3 might look like, and why the Fed might choose this path, please see the Weekly Economic Commentary from March 13, 2012, “To QE or not to QE?”

Why Might the Fed Opt To Do Nothing This Week?

In our view, one of the key reasons the Fed might not want to pursue this course of action (i.e., another round of quantitative easing) as early as this week is politics. A third foray into balance sheet expansion so close to the elections would likely subject the Fed to intense political scrutiny from Congress (and internally as well) and may imperil the Fed’s independence in the years ahead. However, if conditions became so dire that Chairman Bernanke felt it necessary to act to avoid deflation, he would likely have the votes to do so. In this case, Bernanke and the center of gravity at the Fed would probably like to keep some “dry powder” on hand in case conditions in the United States (either economically or fiscally) or abroad deteriorated.

What Else Could the Fed Do This Week?

At various times over the past several years during the Great Recession and its aftermath, the Fed has discussed several alternative measures of influencing the economy via monetary policy. These include:

·         Gross Domestic Product (GDP) targeting. Where the Fed would target a level of economic growth and continue to pursue monetary policies until the GDP target growth rate is achieved.

·         Inflation targeting. Similar to GDP targeting, the Fed would target a specific level of inflation (currently, the Fed’s unofficial target is around 2.0%) and conduct monetary policy until the inflation rate reaches or exceeds the target rate.

·         Target duration of Fed Treasury and MBS holdings. This is similar to Operation Twist, as the Fed would announce a specific maturity or duration target of its holdings of Treasuries or MBS and conduct purchases and sales of these securities until that maturity or duration target was achieved.

In our view, it is unlikely that the Fed will pursue alternative measures at this week’s FOMC meeting, but they remain options should the Fed run out of other ways to impact the economy via monetary policy.

What Can the Fed Do About Europe?

In recent public appearances, various Fed officials have cited the financial and fiscal turmoil in Europe as possible triggers for more monetary policy easing in the United States. Indeed, slowing U.S. economic growth, slumping consumer and business confidence, and downward pressure on domestic inflation from Europe are likely nudging Fed policymakers to act on domestic policy this week.

More globally, the Fed will likely join in any efforts by global central banks to provide liquidity, if warranted, to the global financial system in the weeks and months ahead to help ensure that global financial institutions (banks, insurance companies, and other central banks, central and local governments) can continue to provide consumers, and small and large businesses alike, with credit. As recently as November 2011, the Fed was part of a coordinated effort by global central banks to expand interbank lending in dollars. Similar actions are more likely than not in the coming weeks and months, and can be achieved without the Fed expanding its balance sheet or changing domestic monetary policy in any way.

Does the Fed Change Rates in an Election Year?

For the record, the Fed has either raised or lowered (and in some cases both in the same year!) its short-term policy rate in every single presidential election year over the past 45 years. In general, the Fed wants to avoid mingling in politics during an election year, and it may prefer to hold off on adjusting policy in the months just prior to the elections in November. But when push came to shove, the Fed acted to change policy as conditions warranted and will likely do so again over the second half of this year if conditions warrant.  Fed policymakers would likely prefer to not begin a new round of quantitative easing in the weeks and months leading up to the November 6 elections, leaving the Fed only a narrow window between the scheduled end of “Operation Twist” on June 30, 2012 and the onset of the fall presidential campaigns, which traditionally swing into high gear after Labor Day.

Thus, although there is likely to be political blowback if the Fed decides to act this week, history is on the side of Fed action in this case.

Why Would the Fed Consider Acting This Week?

As we have written in prior Weekly Economic Commentaries, the Fed has a dual mandate to promote low and stable prices and to foster conditions that lead to full employment. Recent data points on employment, the overall economy, and inflation suggest that:

·         The labor market is softening again, with the unemployment rate at 8.2% in June 2012, and is in danger of rising further over the remainder of this year, and may not fall to the Fed’s forecast of 7.9% by the fourth quarter of 2012.

·         The overall economy remains near stall speed and below the Fed’s forecast (2.75% for real GDP growth in 2012 and 2.9% in 2013). The economy grew at just 1.9% in the first quarter of 2012, and thus far in the second quarter of 2012 is on track to post growth closer to 1.5% than 2.0%. Our forecast remains that the economy will grow at 2.0% in 2012.

·         While deflation, a prolonged period of falling prices and wages, is not likely, and both headline and core (excluding food and energy) inflation remain above the FOMC’s forecast range for 2012, headline inflation has decelerated sharply this year and core inflation has stabilized. With plenty of slack in the labor market, wage gains are nearly nonexistent. Since labor costs account for roughly two-thirds of business’ costs, there is little ability to pass through price increases. In addition, inflation expectations (of consumers, businesses, and professional forecasters), a key input to the Fed’s process on monetary policy, have barely budged in recent years and suggest that inflation expectations remain well contained.

·         In addition, the potential for much more restrictive fiscal policy next year as tax hikes and spending cuts go into effect may prompt the Fed to provide more stimulus. Indeed, financial conditions have already worsened (including measures like interbank lending rates, yield curves, credit spreads, price-to-earnings ratios, and the value of the dollar). Although conditions have not deteriorated as much as they did prior to the start of QE2 in the fall of 2010 or summer 2011 prior to the announcement of Operation Twist, financial conditions have deteriorated rapidly since the start of April 2012.

Is There Evidence the Fed Is Failing to Achieve its Dual Mandate?

In recent public appearances, Fed officials of all stripes (hawks and doves) have noted that the Fed is taking into account the lingering financial and fiscal crisis in Europe, as well as the looming fiscal cliff here in the United States. While these issues will likely be discussed at this week’s FOMC meeting, the participants will want to rely primarily on how the economy is tracking towards its dual mandate in making and communicating whatever decision it makes this week.

In the Fedlines section below, we cite recent speeches from two Fed officials who point out that the Fed appears to be failing in one or both of its mandates.

FEDLINES

     Yellen and Dudley Make the Case for More Policy Action From the Fed

The section below contains excerpts from a speech given by Fed Vice Chair Janet Yellen on June 6, 2012, in Boston entitled: Perspectives on Monetary Policy. While Yellen is a well-known monetary policy “dove,” her views are thought to be closely aligned with Fed Chairman Bernanke’s views. “If the Committee were to judge that the recovery is unlikely to proceed at a satisfactory pace (for example, that the forecast entails little or no improvement in the labor market over the next few years), or that the downside risks to the outlook had become sufficiently great, or that inflation appeared to be in danger of declining notably below its 2 percent objective, I am convinced that scope remains for the FOMC to provide further policy accommodation either through its forward guidance or through additional balance-sheet actions. In taking these decisions, however, we would need to balance two considerations." "In particular, as I have noted, there are a number of significant downside risks to the economic outlook, and hence it may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest.”

The section below is text from a speech given by President of the Federal Reserve Bank of New York, William Dudley, on May 24, 2012, in New York City. Dudley is also a well know monetary policy “dove.” We have long viewed Dudley, along with Yellen and Bernanke, as the “center of gravity” of the Fed. His recent remarks can also provide some insight into what the Fed may do next. “As long as the U.S. economy continues to grow sufficiently fast to cut into the nation’s unused economic resources at a meaningful pace, I think the benefits from further action are unlikely to exceed the costs. But if the economy were to slow so that we were no longer making material progress toward full employment, the downside risks to growth were to increase sharply, or if deflation risks were to climb materially, then the benefits of further accommodation would increase in my estimation and this could tilt the balance toward additional easing.”

Hawks: Fed officials who favor the low inflation side of the Fed’s dual mandate of low inflation and full employment.

Doves: Those favoring the full employment side.

Prepared by:

John Canally, CFA

Economist LPL Financial

__________________________________________________________________

IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk including loss of principal.

International investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nation’s open market operations (i.e., the Fed’s buying and selling of United States Treasure securities).

Treasuries: A marketable, fixed-interest U.S. government debt security. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Member FINRA/SIPC

Tracking #1-077073 (Exp. 06/13)

Weekly Economic Commentary

Beige Book: Window on Main Street

Sequel to Last Summer?

This Wednesday, June 6, the Federal Reserve will release its Beige Book — one of our favorite economic reports. The Beige Book compiles qualitative observations made by community bankers and business owners about economic (labor market, prices, wages, housing, nonresidential construction, tourism, manufacturing) and banking (loan demand, loan quality, lending conditions) conditions in each of the 12 Federal Reserve (Fed) districts (Boston, New York, Philadelphia, Kansas City, etc.). Each Beige Book is compiled by one of the 12 regional Federal Reserve districts on a rotating basis — the report is much more “Main Street” than “Wall Street” focused. It provides an excellent window into economic activity around the nation using plain, everyday language. The report is prepared eight times a year ahead of each of the eight Federal Open Market Committee (FOMC) meetings. The next FOMC meeting is June 19 – 20, 2012.

Warm Weather Impact

The Beige Book prepared ahead of the April 24 – 25, 2012 FOMC meeting (released on April 11, 2012) described an economy that was still expanding “at a modest pace.” At that time, there were few signs of the themes that dominated the Beige Books in the summer and fall of 2011: weak confidence, rising food and energy prices, European concerns, and high economic and financial market uncertainty. (Please see our April 16, 2012 Weekly Economic Commentary.) In addition, the numerous mentions of warmer-than-usual weather in the April 11, 2012 Beige Book suggested to us that warm winter weather almost certainly impacted economic activity.

Expansion and Uncertainty

Unfortunately, many of the themes that dominated the Beige Book in the summer and fall of 2011 may reappear in this week’s Beige Book, making it look like a sequel to the ones prepared in the middle of 2011. In addition, the return to more “normal” weather this spring has led to a noticeable cooling of economic activity in recent weeks. We have been describing that as “payback” from the warmer-than-usual winter of 2011 – 2012 that pulled forward hiring, home buying, construction activity, and even some consumer purchases. It will be interesting to see how business and banking leaders describe the weather’s impact on the economy in recent weeks and months. The slowdown in economic activity in China will also likely be mentioned in this week’s Beige Book. On balance, we expect the Beige Book released this week to look more like the sequel to the Beige Books from last summer and fall, rather than the relatively upbeat Beige Books released thus far in 2012.

We do not expect the Beige Book to be all bad news. Indeed, business and banking contacts across the country are sure to note several positives in this week’s Beige Book, including the:

·         Recent drop in consumer energy prices,

·         Continued increase in bank loan activity (to both consumers and businesses),

·         Sharp increase in refinance activity as the result of the sharp drop in mortgage rates,

·         Ongoing revival in the housing market (sales, prices, construction, employment),

·         Dramatic decrease in raw materials costs, and

·         Revival of the manufacturing sector.

In addition, the global supply chain disruptions resulting from the earthquake in Japan that dominated the Beige Books last summer have now been resolved and are not acting as a drag on global growth as they were throughout the final two-thirds of 2011. Notably, compared with the Beige Books released in June of 2008 and 2009 — when the economy was in the midst of the Great Recession — this week’s Beige Book is likely to be far more upbeat.

Behind the Key Words and Phrases

We expect an increase in mentions of uncertainty, Europe, and confidence in this week’s Beige Book, and perhaps even a sharp uptick in the number of mentions of China. Weather mentions will likely remain elevated as well. We don’t expect to see any mentions of Japan/Thailand as it relates to global supply chain disruptions, but we do expect plenty of mentions of lower gasoline, fuel, and commodity prices impacting the economy.

On balance, the Beige Book will likely paint a picture of an economy that is growing, but perhaps growing more slowly than it was just a few months ago. The slowdown in the pace of economic growth here and abroad, growing policy uncertainty overseas and at home, along with a sharp decline in food and energy prices ought to provide the Fed with the scope to pursue another round of quantitative easing later this year, and perhaps even as soon as the end of this month, when Operation Twist is scheduled to end.

______________________________________________

IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. This research material has been prepared by LPL Financial.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Member FINRA/SIPC

Tracking #1-073545 (Exp. 06/13)

Weekly Economic Commentary

Policymakers, Pundits, and Politicians Eye the May Jobs Report

The May jobs report is due out on Friday June 1, 2012, and as always, market participants and policymakers will closely watch the report. This year is an election year, of course, so the politicians and political pundits will have plenty to say about the report as well.

Market participants are looking for an increase of 160,000 private sector jobs in May 2012, a slight acceleration from the 130,000 jobs created in April 2012, but well below the 250,000 per month pace of job creation seen between December 2011 and February 2012, which was likely inflated by much warmer-than-usual weather during those months. The 130,000 private sector jobs added in April 2012 were the fewest in any month since August 2011 (52,000), and most likely represented the final month of “payback” for the warmer-than-usual winter weather that likely inflated the payroll count between November 2011 and February 2012. Last fall, prior to the warmer weather, the economy was creating around 150,000 jobs per month. The true pace of underlying job growth is likely somewhere between 150,000 and 250,000. In our estimation the true pace of employment growth is in the 175,000 to 200,000 range.

Compared to last fall, when the level of initial claims for unemployment insurance was running over 400,000 per week, the level of initial claims filed each week in May 2012 (under 375,000 per week) suggests that hiring is a bit more robust today than it was last fall. Several other indicators suggest that the economy is probably creating more jobs than it was last fall (150,000 per month), but not many more:

·         The increase in consumer sentiment,

·         The better consumer spending in recent months,

·         The near-record level of corporate profits and cash flows,

·         The increase in job openings, and

·         The number of job quitters as a percent of overall job separations.

Policymakers at the Federal Reserve (Fed) also will likely have a keen interest in the May jobs report, which will be the last one prior to the key June 19 – 20 Federal Open Market Committee (FOMC) meeting.

·         If the economy is creating closer to 100,000 jobs per month in the coming months, the Fed is more likely to act to replace “Operation Twist” with some other type of monetary stimulus (QE3) when it ends at the end of June.

·         If, however, the economy is creating around 150,000 jobs per month, it is likely to be a close call whether the Fed announces a new stimulus program.

·         Based on Fed Chairman Ben Bernanke’s statements, job gains over 200,000 or so might see the Fed hold off on more stimulus, although events in Europe or the upcoming fiscal cliff here in the United States might force the Fed‘s hand.

A quick review of Fed Chairman Bernanke’s most recent comments on the labor market may be a helpful guide on this topic. Other than a speech on bank regulation on May 10, 2012, Bernanke has not spoken publicly since his press conference following the April 25 FOMC meeting. And as this publication is being prepared, he is not scheduled to speak again until his press conference after the June 19 – 20 FOMC meeting.

In that April 25 press conference, Bernanke noted that the economy needs to generate around 100,000 or so jobs per month to keep the unemployment rate, currently at 8.1%, steady. He went on to say that the economy needs to generate between 150,000 and 200,000 jobs per month to achieve the Fed’s forecast of lowering the unemployment rate to under 8.0% by the end of 2012. Bernanke said that because of the warmer weather and an unusually strong labor market in the final few months of 2011 and in early 2012, he expected that jobs gains in the months ahead “will be somewhat less than the 250,000 a month that we’ve been seeing recently.” He also said that “we’ll continue to be watching the labor market. That’s a very important consideration. If unemployment looks like it’s no longer making progress, that’ll be an important consideration in thinking about policy options.”

Politicians and pundits will also likely pick apart the May jobs report, although another five jobs reports will be released before the general election on November 6, 2012. When President Obama took office in January 2009, the unemployment rate was 7.8% and rising, hitting a peak of 10.0% in October 2009, four months after the end of the recession.

At the beginning of the 2007 – 2009 Great Recession, the unemployment rate was 5.0%; the rate hit a cycle low of 4.4% in late 2006 and early 2007.

The unemployment rate is currently at 8.1% and still above where it was (7.8%) when President Obama took office. Looking ahead, the Bloomberg consensus says that the unemployment rate will average 8.0% in the fourth quarter of 2012, little changed from where it is today. In fact, only four of the 64 economists recently surveyed by Bloomberg think the unemployment rate will be lower in the fourth quarter than it was when President Obama took office. How the unemployment rate performed during the past 10 presidential elections (1972 – 2008) provides plenty of history from which to draw comparisons.

Comparing the unemployment rate in October of each election year since 1972 to the unemployment rate in January of the first year of the first term, we find that in five election cycles the unemployment rate was the same or lower in October of the election year versus where it stood at the start of the term. Those elections were:

·         1980

·         1984

·         1988

·         1996

·         2000

In three of those five elections (1984, 1988, and 1996) the incumbent was reelected. In the other five elections since 1972, the unemployment rate in October of the election year was higher than it was when the presidential term began. The incumbent party was reelected in two of those five elections: 1972 and 2004. Thus, if the last 10 election cycles are any guide, the President's chances of re-election would increase if the unemployment rate is at 7.8% or lower by October of this year.

Among economic indicators, while the unemployment rate is politically important, and garners a great deal of attention in the media, real after-tax personal income is probably a better economic indicator to rely on to help determine election outcomes. As noted in the April 2, 2012 Weekly Market Commentary, the impact of the economy on the election can most clearly be seen through the relationship between income growth in the year leading up to the election and election results. Inflation-adjusted, after-tax income growth of about 3 – 4% appears to be the threshold for incumbents to get 50% of the popular vote. This measure of per capita income, contained in the most recent (March 2012) Personal Income and spending report, is only growing at 0.6%.

___________________________________________

IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The fast price swings in commodities and currencies will result in significant volatility in an investor's holdings.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. This research material has been prepared by LPL Financial.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Tracking #1-071923 (Exp. 05/13)

Weekly Economic Commentary

The Ebb of Energy & Eating Costs

In the spring of 2011, U.S. consumers were hit with high energy and food prices. This double whammy drove headline consumer prices, as measured by the Consumer Price Index (CPI), from a 1.1% year-over-year gain in late 2010 to nearly 4.0% by the fall of 2011. A rapid acceleration in food and energy prices accounted for most of the acceleration in overall inflation. Combined, these two components of the CPI account for less than 15% of the overall index. But because consumers make purchases of food (grocery stores) and energy (gas stations) quite often, rising prices in these two categories captured the public’s (and the media’s) attention.

Pain at the Pump and in the Grocery Aisle

The sharp acceleration in food and energy prices made headlines nearly every day in the spring and summer of 2011; after all, many Americans make several visits to gasoline stations and grocery stores every week. Higher prices and more related media coverage were a large contributor to the slide in consumer sentiment over the spring and summer of 2011. However, the acrimonious debate in Washington over the debt ceiling and the volatility in financial markets due to the debt ceiling debate and the European sovereign debt problems were also to blame.

Growth in real consumer spending (which accounts for two-thirds of economic activity) slowed sharply between late 2010 and the middle of 2011, from a 3.6% pace in late 2010 to under 1.0% in mid-2011, partly because consumers were diverting some of their discretionary incomes to purchase “must-have” items like groceries and gasoline.

Just how rapid were the price increases in these categories? Energy prices in the CPI accelerated from 4.0% year-over-year in late 2010 to 22% year-over-year in mid-2011, as a gallon of gas increased from under $2.75 in the fall of 2010 to nearly $4.25 in the spring of 2011. The rise in gasoline prices, in turn, was driven largely by the Arab Spring uprisings that rolled across the Middle East in the winter and spring of 2011, driving oil prices from around $70 per barrel in September 2010 to as high as $114 per barrel in April 2011.

Food price inflation accelerated from under 1.0% year-over-year in the fall of 2010 to a 6.3% year-over-year gain in the fall of 2011. That rapid increase, which was accompanied by almost constant reinforcement from local and national media about rising prices for staples like bread and milk, was a result of a near-doubling of agricultural commodity prices between mid-2010 and early 2011. The rise in prices for agricultural commodities was largely the result of supply shocks caused by poor weather, reduced inventory levels of key agricultural commodities, and a full resumption of economic activity in low and middle income countries around the world.

Fuel Fares

This year, food and energy prices are more muted, and should head lower over the remainder of 2012, with food prices leading the charge lower. Gasoline prices again reached $4 per gallon this spring but have receded sharply since the early April peak in prices. Here again, gasoline prices are being driven by oil prices. Until recently this year, oil prices have held in a narrow range between $95 and $110 per barrel, hitting the high end of that range in late February 2012, amid concerns over an attack on Iran’s nuclear facilities. Since early May 2012, oil prices have dipped to nearly $90 per barrel amid concerns that global economic growth will slow as the European fiscal crisis flares up again. A spike higher in oil prices is possible later this year if: 1) there is more unrest in the Middle East; 2) there is an active Atlantic hurricane season; or 3) tensions around Iran’s nuclear capabilities flare up again. However, oil prices are likely to remain near $100 per barrel, which suggests that gasoline prices should remain under $4 per gallon. Gasoline near or under $4 over the remainder of the year would put little upward pressure on the CPI for energy products, and would help drive headline CPI back under 2.0% by the end of the year.

Grocery Prices Going Down

The bigger driver of further deceleration in headline inflation, however, may be food prices. Changes in the price of agricultural commodities leads to changes in food prices, as measured in the CPI by around seven months. As noted above, prices of agricultural commodities surged in 2010 and early 2011, but have moderated since, turning negative on a year-over-year basis late in 2011. Prices of agricultural commodities have dropped by nearly 25% since peaking in early 2011, and are down 17% from a year ago. The drop in prices of agricultural commodities came as weather improved, inventories were built, and as some global trade policies normalized. If the traditional relationship holds between prices of agricultural commodities and the CPI for food, we could see food prices turn negative on a year-over-year basis by the fall of 2012. This would continue to push headline inflation below 2.0% (from the current 2.3% year-over year reading), providing the Federal Reserve with enough wiggle room to embark on another round of quantitative easing (QE3) if necessary later in the year.

On balance, the surge in food and energy prices that drove headline inflation sharply higher in the spring and summer of 2011, which weighed on consumer sentiment and sharply curtailed consumer spending in early to mid-2011, has faded. Prices of energy and agricultural commodities have been much better behaved in 2012, and point to decelerating headline inflation over the remainder of 2012.

___________________________________________

IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The fast price swings in commodities and currencies will result in significant volatility in an investor's holdings.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. This research material has been prepared by LPL Financial.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Tracking #1-070130 (Exp. 05/13)