Last Week’s Highlights:

Economics This Week:

Markets Strong Out of the Gate, but Stumble on Poor Housing Data

Following a strong start to the week, equity indices rolled after weak news on the state of the housing market.  The Dow Jones Industrial Average held steady with a 0.5% gain while the S&P 500 index fell by 0.2%. 

Equity indices were stretching for new highs on the year in the beginning of the week, but a combination of disappointing news on housing starts and rising foreclosures left an unsavory taste in investor’s collective mouths.  Markets gained confidence following a strong report on retail spending, which jumped 1.4% in October, after a downwardly revised 2.3% drop in September.  Subtracting the outsized gains in autos, core retail sales gained 0.5%, offering analysts a glimmer of hope that consumers are coming out of hibernation this holiday season. 

Source: Haver Analytics

That mood changed come Wednesday, however, as housing starts fell almost 11% in October, with single family starts off by 7% and multi-family starts down nearly 35%.  Pinpointing a definitive source of the weakness is difficult but it appears that concern over the November 30th expiration of the home buyer tax credit caused builders to back away from the market.  This serves as a reminder that direct government intervention is a necessity in the current environment and an extension of the credit into the spring will bolster housing starts for the next few months, but prospects for a quick housing recovery are fading. 

After poor news on housing starts, the Mortgage Bankers Association joined the party with the release of its quarterly National Delinquency Survey.  We found out that what began with subprime borrowers is now creeping up to the prime level.  The delinquency rate hit 9.9% across all loans and the percentage of loans in foreclosure or a minimum of one payment past due is 14.4%.  Prime loans, which represent approximately 76% of the total market, showed a delinquency/foreclosure rate slightly above 10% at the end of the 3rd quarter but this pales in comparison to the greater than 40% delinquency/foreclosure rate at the subprime level.  A frustratingly weak job market will contribute to housing weakness, another headwind for future Fed rate hikes. 

Officials from the Federal Reserve were out in full force this past week, offering various opinions on the current and future state of the economy.  Chairman Bernanke led the way on Monday with a discussion before the Economic Club of New York.  Bernanke views current growth as being driven by more than “temporary factors” and he expects growth to continue through 2010.  However, Bernanke acknowledged that a scarcity of jobs will cause consumers to spend more prudently. 

On the topic of inflation, Bernanke continued to reiterate the Fed’s stance that interest rates would be likely to stay low for an “extended period” but left it up to St Louis Federal Reserve President Bullard to offer up 2012 as the possible definition for the word extended.  Bullard’s comments surprised many analysts who were estimating that rate hikes would start in the middle of 2010.  Although Bullard does not hold an FOMC vote this year, he will rotate into the voting ranks next year, so his comments should not be taken lightly. 

On Thursday, yields on T-bills crept into negative territory, providing panicky investors a feeling of déjà vu, after a similar occurrence one year ago (as well as last quarter).  It seems this was merely a case of banks readjusting their balance sheets ahead of yearend financial reporting.  Another precipitating factor is the conversion of investment banks (Goldman Sachs, for instance) to bank holding companies, shifting their reporting period in line with commercial banks.  Yields on 1-month t-bills were higher than those on the 3-month bill, another sign that banks were trying to beat out New York’s infamous retail shops for the best year end window dressing. 

Wherefore art Thou Inflation?

News on inflationary pressure was both positive and negative during the past week, but it remains obvious that concerns about an inflationary episode are still premature. 

The inflationary talk began with the Federal Reserve Bank of Philadelphia releasing the 4th quarter 2009 Survey of Professional Forecasters.  Inflation prognostications from the “professionals” have been well anchored since the late 1990s, holding steady in the 2.4% to 2.5% for 10-year CPI forecasts. Contrary to popular opinion, that trend broke down in the most recent survey, falling to 2.26%.  There is no clear cut answer for what may have precipitated this decline, but it appears that forecasters are now looking for an extremely benign inflation environment over the next four years, before a return to above trend inflation in the middle of next decade.    

Source: Gluskin Sheff

That notion was supported by data at the producer level, with headline PPI rising 0.3%, but core PPI falling 0.6%.  As is usually the case, gains in the headline PPI were fueled by increases in food and energy prices.  Core PPI data was also thrown off by the addition of prices for 2010 model year vehicles, which led to a 5% drop in light vehicles and a 0.5% drop in passenger cars.  Producers are coping with higher energy costs, but so far struggling to pass those costs through end consumers. 

Source: Federal Reserve Bank of Cleveland

From the perspective of the consumer, the news is not that dissimilar.  Headline CPI added 0.3% and the core rate rose by 0.2%.  There was a degree of skew in this data, as well, with a spike in the prices of used cars and trucks contributing over 90% of the gain to the core rate.  Owners’ Equivalent Rent was flat during the month, and it is expected that weakness in the housing market will drag CPI lower throughout 2010.  The trimmed mean CPI, a variation of CPI from the Federal Reserve Bank of Cleveland, which accounts for volatile outliers, also increased 0.2% while the median CPI rose 0.1%, suggesting that a few outlier events are manipulating the overall data. 

Volatility in food and energy prices is masking the overall downward trend in inflationary pressure.  With consumers on the mend and housing on unstable footing, it is apparent that dis-inflation will rule the day in the immediate future. 

The Week Ahead

The holiday shortened week will bring no lack of important data.  Existing Home Sales will start the week with economists expecting October sales of 5.7 million.  This would mark the sixth gain in seventh months, and economists suspect that the original November 30th deadline for the home buyer tax credit propelled sales in the month. 

Tuesday brings amended GDP figures, as well as the Case Shiller Home Price Index and the FHFA House Price Index.  Analysts are looking for a big downward revision to GDP due to weaker personal consumption and changes to net exports.  The Case Shiller index showed positive gains over the last four months, furthering hopes that a housing bottom is being established.  A similar story is emerging from the FHFA Home Price Index, although it should be noted that this index is limited to conforming loans through Fannie Mae and Freddie Mac.  On Tuesday afternoon, minutes from the November FOMC meeting are set for release.  Analysts are looking for any clarity about future rate hikes and the Fed’s view on the state of the economy. 

The report on Personal Income and Outlays is out on Wednesday.  September’s report was weak primarily due to the end of the cash for clunkers program, but that should allow October to rebound as auto sales picked back up.

Despite the short week, the Treasury is coming to market with another mind boggling amount of supply.  Issuance will total $118 billion across two year ($44 billion), five year ($42 billion) and seven year ($32 billion) auctions.  That is in addition to $61 billion of short term bills.  With short term yields near record low territory, there is concern that the bid-to-cover ratio (a measure of demand) for the two year auction will be disappointing.  Markets will closely watch those results on Monday.  

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