Competing For Attention
Housing, the Federal Reserve’s (Fed) monetary policy, and the manufacturing sector in early 2011 are likely to compete for market participants’ attention this week. This data comes amid a flurry of corporate earnings reports for the fourth quarter of 2010 and guidance for 2011. Overseas this week, another round of Chinese economic data for December, more hand wringing about the European fiscal situation, and interest rate decisions from no fewer than seven central banks are on tap. In addition, markets will continue to digest and debate last week’s full slate of economic data in the United States, which helped to boost expectations for real gross domestic product (GDP) growth in the recently completed fourth quarter of 2010. GDP growth is likely to accelerate to 4.0% in the fourth quarter, after averaging about 2.5% over the first three quarters of 2010.
Manufacturing, Housing and the Fed On the Docket This Week in the United States
The Empire State (released as this report was being prepared) and Philly Fed (Thursday, January 20) manufacturing surveys for January offer the first look at the manufacturing sector in 2011. As market participants digest these reports, the key question will be: Can the manufacturing sector continue to accelerate into 2011, or are we due for a deceleration soon? Business capital spending, and exports (both driven in large part by manufacturing) have grown faster than consumer spending in every quarter since the second quarter of 2010. That string may have been broken in the fourth quarter of 2010, although we continue to expect manufacturing, along with business spending and exports, to continue to add to GDP in 2011.
Housing, which has added to real GDP growth in just one quarter (the third quarter of 2010) in the past four years, is big news this week. Reports on homebuilder sentiment in January (released as this report was being prepared), housing starts (Wednesday, January 19) and existing home sales (Thursday, January 20) for December are due out. As noted above, housing construction — although a small part of GDP — has been a drag on GDP growth in 16 of the past 17 quarters. The good news is that unassisted by any government programs, the housing market seems to have found a floor. But the question is: Can the housing market reaccelerate on its own, and can it do so with only modest job and income growth and still stringent bank lending standards? Our best guess is that housing will continue to muddle along, not significantly adding to (or subtracting from) GDP growth in 2011.
In the last public appearance by a Fed official ahead of next week’s Federal Open Market Committee (FOMC) meeting, the president of the Philadelphia Fed, Charles Plosser, is scheduled to deliver a speech this week in Chile. While Fed officials do not often break any new ground when speaking overseas (let alone a first time voter on the FOMC speaking the week before the FOMC meeting), Plosser’s speech will be closely monitored. Plosser is a well-known inflation “hawk”, and will likely cast a vote against continuing the Fed’s program of quantitative easing. There will likely be other dissenters at the January 26 FOMC meeting as well, but our view is that despite the political pressures, the hurdle for the Fed to end QE2 early is high, and the hurdle to start QE3 in June 2011 is even higher.
Elsewhere, bad weather will dominate the weekly data on claims and retail sales this week. With more wintry weather along the East Coast this week, market participants are beginning to ask: How long will it be before we can get a clean reading on the economy in early 2011? The Martin Luther King holiday, along with persistently harsh winter weather — that continued into mid January — are likely to disrupt the economic data for the next several weeks, especially the weekly readings on retail sales and initial filings for unemployment insurance. As a result, market participants may have to wait until early February to get a better gauge on the underlying health of the economy in early 2011.
Several Surprise Rate Increases Last Week as Emerging Markets Combat Domestic Inflation Worries
There were many signs in last week’s batch of economic data for late 2010 and early 2011, that the United States economy gathered steam as 2010 ended and 2011 began, although more wintry than usual winter weather made some of the data even more difficult to interpret than usual. Last week’s economic data in China for December continues to point to more policy tightening in China in the coming weeks and months. Several central banks around the globe did actually raise rates last week, including South Korea, Chile, Serbia and Thailand. All four have been raising rates for some time now to combat domestic inflation, although the rate hikes in Chile and South Korea were unexpected. The data released in the United States last week included reports on retail sales, inflation, jobless claims and the Beige Book. In addition, the data released in China last week continues to argue for more tightening there.
A Strong Finish to 2010, and a Solid Start to 2011
A quick recap of last week’s key data in the United States and China is below:
The United States government’s tally of December retail sales suggested that overall December retail sales were soft, but that holiday and overall consumer spending in the fourth quarter of 2010 were quite strong. As noted above, consumer spending in the fourth quarter of 2010 is on track to outpace business spending for the first time since early 2009.
Perhaps impacted by bad weather right before and right after Christmas, retail sales in December fell short of expectations. However, the strength in sales in November indicates that holiday shopping may have started earlier this year than last. Over the final two months of the year "holiday" sales posted a 7% gain over the final two months of 2009, the best performance since 1999. Overall, retail sales have now climbed all the way back to their pre-recession, mid-2007 peak. In addition, the growth rate of all major categories of retail sales accelerated between Q3 2010 and Q4 2010, suggesting much stronger consumer spending in the fourth quarter of 2010 than the third quarter growth rate of 3.2%. Finally, the level of core retail sales in December 2010 was higher than the fourth quarter 2010 average, imparting some upward momentum to spending as 2011 begins.
December consumer and producer prices were driven higher by energy and tobacco prices, but core inflation remains subdued. Both producer price and consumer price indices for December were pushed higher by surging gasoline prices, but behind the headlines on higher raw materials, energy, and grocery prices, inflation remains tame.
The overall consumer price index (CPI) rose 0.5% between November and December, pushed higher by gasoline (+8.5%) and tobacco (+0.8%) prices. The 0.5% month-over-month increase in the overall CPI was the strongest since June 2009, and may raise concerns about a spike higher in inflation. However, a quick look behind the headlines suggests a much more benign price environment, as consumer prices excluding food and energy (core CPI) rose just 0.1% month-over-month in December and were up just 0.8% from December 2009. At 0.8% year-over-year, core inflation remains well below the lower end of the Fed's unofficial comfort zone for core inflation of 1.5% to 2.0%. The benign December core CPI data provides the Fed with more support to continue QE2.
How can prices at the grocery store be rising so quickly (prices for meats, poultry, fish and eggs in December 2010 were 6% higher than December 2009, while prices for milk and dairy products were 4% higher) and overall inflation be so tame? Core inflation accounts for 78% of overall CPI, and includes, among other items, measures of housing prices and rents (42% of CPI), computers, cell phones, apparel and household furnishings including televisions, appliances and furniture.
Taken together computers, cell phones, apparel and household furnishings account for nearly 15% of the CPI, while items like groceries (8% of the CPI) and gasoline (4% of CPI) account for an ever-smaller (around 12%) portion of our spending. In general, prices of computers, cell phones, apparel, appliances, and furniture are falling, and that decline in prices helps to offset the big increases in food and gasoline prices over the past year. But since our purchase of groceries and our trips to the gas station to “fill ‘er up” are more frequent than our trips to the appliance store or the furniture store or the clothing store, it sure does seem like inflation is rising faster than it actually is.
Initial claims for unemployment insurance spiked higher last week, but weather and holidays are the likely culprit, not a deteriorating labor market. More people filed for unemployment insurance in the week ending January 8, 2011 (445,000), an increase of 35,000 from the prior week. The consensus called for just 410,000 individuals to file. As we have noted in recent weeks, the weekly jobless claims data between mid-December and mid-January are always difficult to interpret. Severe winter weather makes the data even more suspect. While we cannot dismiss the latest reading entirely (there is a chance that the labor market deteriorated in late December and early January), we would like to see a few "clean" readings on claims before reaching that conclusion. Unfortunately, the latest round of foul weather in some parts of the country along with the Dr. Martin Luther King Jr. Day federal holiday will continue to distort the data in the coming weeks.
The Fed's Beige Book, a qualitative assessment of economic activity in each of the 12 regional Federal Reserve districts (Boston, New York, Philadelphia, Atlanta, Dallas, etc.), found that the economy continued to expand between the December 14 FOMC meeting and early January 2011. Business and banking contacts reported better hiring, very good holiday sales, and some improvement in commercial real estate. Bank loan demand and lending activity was mixed, while residential real estate remained weak. On the price front, while there was more evidence of higher input prices impacting some businesses, there was little evidence that these were being passed on to the end user. Wages, which account for 70% of business costs, continue to be quite subdued, suggesting that widespread consumer inflation is unlikely any time soon. The Beige Book was prepared ahead of the next FOMC meeting, which is set for January 26.
Chinese authorities released money supply and bank loan data for December last week. December money supply growth (one of the most reliable and least politically influenced economic data points in China) unexpectedly accelerated in December and while new loan growth decelerated between November and December, loans exceeded expectations. The economic data in China has been slowing (albeit from a very rapid pace of growth) since early- to mid-2010, and more deceleration is likely into 2011. Real GDP growth in China is expected to be near 9.5% year-over-year in the fourth quarter of 2010, and is expected to grow at that pace in 2011 as well. Real GDP growth began the year at 12.0%. We continue to expect more tightening of policy in China in
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Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
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 Philadelphia Fed Survey is a business outlook survey used to construct an index that tracks manufacturing conditions in the Philadelphia Federal Reserve district. The Philadelphia Fed survey is an indicator of trends in the manufacturing sector, and is correlated with the Institute for Supply Management (ISM) manufacturing index, as well as the industrial production index.
Empire State Manufacturing Survey is a monthly survey of manufacturers in New York State conducted by the Federal Reserve Bank of New York.
Quantitative Easing (QE) 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.
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