The stock market rallied this week, largely as a result of lower oil prices, the possibility of a pause in the Fed’s recent rate hikes and expectations of a rebuilding boom for the Katrina affected areas. In addition, there were some indications of a strong economy before Katrina. The Fed released the Beige Book, which basically stated that the economy was on firm footing. The ISM number (see below) indicated the service sector of the economy was poised to grow. In addition, Texas Instruments gave a very upbeat earnings call late in the week, boosting tech shares. Technically, all three markets were a key reversal levels at the beginning of the week and were technically oversold. This implies that program trading most likely contributed to the gains. Finally, the S&P 500 closed at a three year high.
The Treasury market spent the week worrying about inflation and the possibility of a pause in the Fed’ rate increases. The market sold-off on Tuesday and Wednesday because of the rising employment costs (see below) and concern economic growth would lead in inflationary pressures. Two Fed governors gave speeches indicating inflation was still a concern. However, as various economists cut their GDP growth forecasts, traders started to bid-up Treasuries on Friday, as this is an indication of lower inflationary pressures in the economy. There were two treasury auctions this week. The Treasury sold 13 billion in 5 year notes on Wednesday. Foreign Central Banks (Indirect Bidders) purchased 55% of the issues. The Treasury auctioned 8 billion 10-year notes on Thursday. Indirect bidders purchased 22.1%. This number should not raise much concern, as most investors will shorten their maturities in a rising interest rate environment.
To understand the oil market’s reaction to Katrina, it is important to remember the market was technically very overbought for the previous week. There was also a fair amount of panic buying, especially as reports of refinery shut-ins came out daily from the Minerals Management Service. As a result, this week’s sell-off was the result of some technical sales based purely on price and reaction to the international communities pledge of 60 million barrels of oil to the US. In addition, as more production came on line, traders’ tension about a possible gasoline shortage eased somewhat. However, the refinery situation is far from over. Yesterday, a commentator on Bloomberg television stated some refineries would be down for at least a month and possibly longer. The Department of Energy issued a statement that winter heating prices could increase 71% in some areas. In short, the situation is very fluid.
The currency markets spent the week debating whether or not the Fed would pause its recent interest rate hikes. Since the beginning of the year, forex traders have focused on the interest rate and growth rate differentials between various economies, bidding up currencies with higher interest and growth rates. As a result, the dollar has rallied since the first of the year. There was concern among traders the Fed would halt its recent interest rate hikes, largely as a political gesture to Katrina. However, the CBO issued a report stating Katrina would hurt, but would not be devastating and several Fed governors gave hawkish speeches this week leading traders to believe rate hikes would continue with no pause.
Tuesday: ISM Non-Manufacturing Survey
The report was issued today by Ralph G. Kauffman, Ph.D., C.P.M., chair of the Institute for Supply Management Non-Manufacturing Business Survey Committee and coordinator of the Supply Chain Management Program, University of Houston-Downtown. “Non-manufacturing business activity increased for the 29th consecutive month in August,” Kauffman said. He added, “Business Activity increased at a faster rate in August than in July. New Orders, Employment and Inventories also increased at faster rates. Many members’ comments expressed concern about the continuing increase in oil and gas prices and its impact on the prices of other items and on budgets. The overall indication is continued economic growth in the non-manufacturing sector in August at a faster rate of increase than in July.”
The best news in the survey was the large +10 export orders increase, which bodes well for the trade deficit figures. Business activity increased 4.5 and employment increased 3.9 – again, more good news. In full, this is a very positive report. There is an inexplicable situation contained within the report. Overall, reported prices paid decreased. Bur, over 25 commodities categories increased in price compared to under less than 10 that decreased. This is an odd contradiction that has no explanation. In addition, from a reconstruction of storm damage, steel and concrete are in short supply, implying price spikes are more likely with these commodities.
Wednesday: Productivity and Labor Costs
The seasonally adjusted annual rates of productivity change in the second quarter were:
0.7 percent in the business sector and
1.8 percent in the nonfarm business sector.
Productivity is the amount of goods produced per a unit of time, usually by the hour. The US productivity rate has increased a great deal since 2001. There are some economists who argue the increase is due to the use of technology from the late 1990s expansion. Whatever the reason, an increase in productivity allows a business to produce the same amount of goods with fewer resources. This lowers the overall cost of the product to the business, allowing them to make larger profits. A sustained productivity increase also slows hiring practices because a business does not need as many employees to perform a specific task.
Productivity increases have been slowing for the last few quarters. This is one reason some economists have argued for a better employment picture, as lower productivity would force companies to increase payrolls.
Unit labor costs rose 2.6 percent in the second quarter of 2005.
This number is very important; it is one of Greenspan’s key indicators. It indicates the amount of inflation occurring at the business level. This was the largest increase since 2000. The size of the increase harmed the argument the Fed would pause its interest rate hikes at the next meeting as a result of Katrina, as the Fed would probably place fighting inflation over a temporary pause.
Thursday: Wholesale Inventories and Sales
The U.S. Census Bureau announced today that July 2005 sales of merchant wholesalers, except manufacturers’ sales branches and offices, after adjustment for seasonal variations and trading-day differences but not for price changes, were $298.7 billion, up 0.5 percent (+-0.7%)* from the revised June level and were up 7.5 percent (+-1.2%) from the July 2004 level.
Total inventories of merchant wholesalers, except manufacturers’ sales branches and offices, after adjustment for seasonal variations but not for price changes, were $352.0 billion at the end of July, down 0.1 percent (+-0.3%)* from last month, but were up 8.2 percent (+-1.0%) from a year ago.
The July inventories/sales ratio for merchant wholesalers, except manufacturers’ sales branches and offices, based on seasonally adjusted data, was 1.18. The July 2004 ratio was 1.17.
Wholesalers stand between manufacturers and retailers in the supply chain. Manufacturers sell to wholesalers who in turn sell to retailers. Therefore, keeping track of their inventories and sales is a way to gauge the health of the economy.
An increase in their overall sales is positive because it indicates their customers – retailers – are purchasing goods, anticipating sales.
Wholesaler’s inventories indicate how bullish they are on the economy. If they start to stock up on goods, it indicates they are bullish about the next few months. However, it is important to note the overall economy has become more fluid as a result of the just-in-time inventory system. Businesses as a whole does not need to keep their inventories nearly as high as past years because information technology (computers and the like) and rapid transport such as Fed Ex and UPS. Therefore, a drop in inventories and a decreasing inventory/sales ratio is not as bearish as previous years.
The largest increases from June occurred in motor vehicle and related parts (1.9%), lumber (1%), apparel (1.9%) and petroleum (7.6). Apparel increases are the result of back-to-school sales and auto sales are the result of the automakers employee pricing discount sales promotion. The latter may have positively skewed the results making them larger than they should be.
Friday: Import Prices Index
The price index for U.S. imports increased 1.3 percent in August, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Rising petroleum prices led the increase for the third consecutive month. U.S. export prices declined 0.1 percent in August after a modest 0.1 percent upturn in July.
Import prices continued a steady upward trend in August, increasing 1.3 percent following advances of 1.2 percent and 0.8 percent in June and July, respectively. The August increase was the largest monthly gain since a 2.2 percent increase in March, and import prices rose 7.6 percent over the past year. Following the pattern of the prior two months, the August increase was driven by higher petroleum prices, which rose 7.1 percent. August marked the third consecutive month that the price index for petroleum imports recorded its highest level since the index was first published in 1982. Petroleum prices rose 42.5 percent over the past 12 months. Nonpetroleum prices were unchanged in August after decreasing 0.2 percent in each of the three preceding months. Despite those recent declines, nonpetroleum prices increased 1.8 percent for the year ended in August.
Outside of oil, prices are tame. However, oil’s increasing prices combined with US dependence on oil is creating a policy problem for the Federal Reserve. Because of oil’s dominance in the economy, the Fed must pay attention to price increases. However, raising rates based solely on a single commodities price performance is difficult, even if the commodity is vitally important to the economy. The markets were pleased with the tameness of the “core” number, essentially discounting the policy implications of the spike in oil prices.