5:00 PM EDT :Treasuries took moderate losses today as stocks finished the month with a rally. In late trading, the 10-Year Treasury Note was down by 6/32, raising its yield to 4.53%; the Dow was up by 119.01 points to 13,357.74; and the Nasdaq was up by 31.06 points to 2,596.36.
News that the administration is addressing the problems of rising mortgage delinquencies and foreclosures with a new FHA refinancing program helped ease credit and liquidity concerns and blocked some of the safe haven flow toward Treasuries. This theme was underscored when Fed chief Ben Bernanke said "The Federal Reserve stands ready to take additional actions [besides recent short-term injections of cash into the monetary system and the cut to the discount rate] as needed to provide liquidity and promote the orderly functioning of markets."
Much of the economic data released today also favored stocks. Personal income and spending rose more than expected last month. Factory orders were also up more than predicted in July. The Chicago PMI indicated a stronger expansion of manufacturing activity in the region than observers were expecting. And the Consumer Sentiment Index edged up slightly in the latter part of August, though it was still much more pessimistic than July's final index reading.
Aside from the economic data and credit situation, the markets were reacting to end-of-month, pre-Labor Day position squaring. The progress in the stock market came despite a rise in oil futures. High energy prices often dampen stock trader sentiment since they act as a brake on the economy. A barrel of light, sweet crude oil for October delivery rose by $0.68 on the New York Mercantile Exchange to settle at $74.04. This was the highest close for a front-month contract since August 3. But for the month, the price fell by $4.17 from the record high close of $78.21 on July 31.
By the end of stock trading, the Dow was up by 0.90%, the S&P 500 by 1.12%, and the Nasdaq by 1.21%. For the week, the Dow edged down by 0.16% and the S&P 500 by 0.36%. The Nasdaq gained 0.76% since last Friday's close. For the month, all three indices made progress with the Dow gaining 1.10%; the S&P 500, 1.29%; and the Nasdaq, 1.97%. And despite today's losses in the bond market, the benchmark 10-Year Treasury Note yield fell by 9 basis points this week (yield moves inversely to price). For the month, the yield fell by 21 basis points. It fell by 29 basis points in July.
Next week's economic calendar contains the two, early-month heavyweights: the national manufacturing index and the employment report. Following the three-day weekend, traders will be facing the manufacturing release on Tuesday. In last month's release, the Institute for Supply Management (ISM) reported that its index came in at 53.8 in July. This was down from June's reading of 56.0. Any reading over 50.0 indicates a general expansion of activity relative to the preceding month and July's represented a sixth consecutive monthly expansion.
The index trended down from late October of 2005 to the beginning of this year, posting slight contraction readings last November and then again in January -- the first since May of 2003. But the sector has been recovering and June's reading was the strongest in fourteen months. But July's was the weakest in four months and for August, the index is predicted to have slipped once again to about 53.0.
Another important item in the manufacturing data is the price index, a measure of inflation in the sector. July's price index of 65.0 was welcomed by observers. Though it still indicated a solid increase in prices, it was the weakest expansion indicator in five months.
Also out on Tuesday is the report on construction spending for July. In the last report, the Commerce Department said the seasonally adjusted, annualized pace of spending fell by 0.3% in June following four consecutive increases. But spending in the residential sector continued to slide. The rate fell by 0.7% in June, a thirteenth consecutive contraction. Given the state of new home construction, permit issuance, and sales, the weakness in the residential spending pace came as no surprise. Another decline in the residential sector is forecast for July. The overall construction spending rate is expected to have been flat (0.0%).
On Wednesday afternoon, the Federal Reserve will release its latest edition of its Beige Book. The Beige Book, so named for the color of the hard copy cover) is an anecdotal summary of economic conditions in the twelve Fed regions and the monetary policy committee uses it as one of its background resources during its policy deliberations. The next committee meeting is September 18.
Though the summary is often overlooked because other reports have already sketched out the economic situation, Wednesday's release will get added attention for what it says about the recent changes in the credit market. Though the last regular policy meeting on the 7th ended with no change in interest rates or policy position, a liquidity crunch caused by a nosedive in demand for certain mortgage-backed securities forced the Fed to inject additional short-term reserves into the monetary system and cut the discount rate (the rate changed to banks for loans directly from the Fed).
(Note: the ISM Services Index, originally reported here that it would be released on Wednesday, will actually be released on Thursday.)
On Thursday, the jobless claims report may also get additional attention because it heralds the approach of Friday's employment report. The data collection periods for the two reports do not coincide (the employment information for the month was collected before this week's jobless claims were made). But the trend in claims can provide insight on the state of the labor market and the latest trend has been bearish. In yesterday's report, the Labor Department said that the seasonally adjusted level of initial claims for state unemployment benefits rose last week by 9,000 to 334,000. The unexpected increase was the largest since the week ending June 16 and the level was the highest since the week ending April 14. The four-week moving average, which smoothes out some of the short-term volatility, rose by 6,250 to 324,500, the highest reading since the week ending April 28. The average weekly reading for the year to date is 318,118.
Continuing claims for the week ending August 18 (continuing claims must be at least a week old) rose by 13,000 to 2.579 million, the highest level since the week ending April 14. The four-week average rose by 11,250 to 2.561 million, its highest level since the week ending January 14. The average weekly reading for the year so far is 2,525,545.
While the claims data still indicate that hiring continues to exceed layoffs, the rising claims levels point to a diminishing gap between the two processes.
The revised report on productivity for the second quarter also comes out on Thursday. The preliminary report, released on the 7th, said the seasonally adjusted, annualized rate of nonfarm business productivity (output per hour) rose in the second quarter by 1.8% following a 0.7% rise in the first quarter. The average cost per hourly unit of output -- or unit labor costs (ULC) -- rose by 2.1% in the second quarter according to the preliminary report. This was a deceleration from a 3.0% rise in the first quarter.
The upward revision to gross domestic product growth in the second quarter from 3.4% to 4.0% suggests that the initial productivity estimate will also be revised higher. Analysts are looking for a 2.3% gain in Thursday's release. Strong productivity usually eases labor costs, reducing inflation pressures and giving the Fed more leeway to cut interest rates. This is good for both stocks and bonds. High productivity is additionally beneficial for stocks since it reflects greater efficiency and suggests improved corporate earnings. The preliminary ULC number is expected to have been trimmed in the final report to about 1.7%.
Also on Thursday, the ISM will release its index data on the non-manufacturing, or services, sector of the economy. Though the services sector is much larger than the manufacturing sector, the data series does not carry the same clout as the manufacturing data. One reason is the very size of the services sector. It is so large that extremes offset one-another and broad-based changes are necessary to make a significant impact on the overall index. Another reason the services data is less market moving than the manufacturing information is that the services data series is relatively young (begun in 1997 vs. 1948 for the manufacturing series).
July's index came in at 55.8. As is the case with the manufacturing index, any reading over 50.0 indicates general growth and July's reading represented a fifty-second consecutive monthly expansion. However, this was down from June's fourteen-month high of 60.7. The drop was the largest since September of 2005. The index for August is expected to show another slip to about 54.5.
The main event on Friday is the release of the employment report for August. Forecast misses are frequent and have been known to roil the markets so traders have learned to exercise caution ahead of the monthly releases. July's report was weaker than expected. The Labor Department said that the seasonally adjusted level of nonfarm payrolls rose by just 92,000, the smallest increase in five months and the second smallest increase since November of 2004. Moreover, June's originally reported rise of 132,000 was revised down by 6,000 to 126,000.
The report said that the unemployment rate, the portion of the active workforce without jobs, edged up to 4.6% in July from June's rate of 4.5%. The increase was the first since April and the rate was the highest since January. Nevertheless, it is still considered low by historical standards.
For August, forecasters are predicting a payroll increase of about 120,000. The unemployment rate is expected to have remained at 4.6% or to have edged up to 4.7%. A 4.7% reading would be the highest in the last twelve months.
The final economic news scheduled for next week is the report on wholesale inventories and it is likely to be overshadowed by the jobs report. For one thing, the wholesale sector is only one component of the inventory picture. A report on business inventories -- which includes data from the manufacturing, wholesale, and retail sectors -- will be released on the 14th. For another thing, the information is somewhat dated as Friday's report is for the month of July.
Wholesale inventory growth has been relatively steady this year so far. The average monthly change has been an increase of 0.4%. Inventories were up by 0.5% in both May and June and an increase of 0.4% or 0.5% is predicted for July. Sales have been strong, averaging 0.9% increases in the first six months of the year. They were up by 0.6% in June following a 1.3% rise in May.
The combination of inventory and sales changes has kept inventories at extremely lean levels. The inventory-to-sales (I/S) ratio was a record low 1.11 in both May and June. The I/S ratio is the value of remaining inventory divided by the value of sales for the month. The result indicates how many months it would take to entirely deplete stocks on hand. A low ratio indicates strong pressure to replenish supplies. Even if sales were soft in July, the I/S ratio would only be marginally affected.
10:30 AM EDT :
Treasuries are down this morning and stocks are up as the flight to the government backed sector is waning on talk of bailing out mortgagors caught between rising payments and falling home values. News reports this morning say President Bush will be recommending a set of initiatives today aimed at addressing the mortgage situation. The development lends some support to securities backed by mortgages and the complex structure of financial relationships into which such securities are intermixed.
This news was followed up by a speech this morning by Federal Reserve Board Chairman, Ben Bernanke. In his keynote address at a central bank symposium at Jackson Hole, Wyoming, he spoke on "Housing, Housing Finance and Monetary Policy." His discourse outlined the development of the U.S. housing industry and its impact on the economy. Of particular note are his comments on the Fed's recent actions and their relationship to the current housing / mortgage situation.
Some critics have said that the Fed has no business bailing out financial market participants. Mr. Bernanke responded in his address this way, "It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy."
With regard to upcoming Fed decisions on monetary policy, Mr. Bernanke said, "economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as
needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."
(BERNANKE ADDRESS)
The economic data released today was also unfavorable to bonds; that is, it was more bullish than anticipated, which lessens pressure on the Fed to cut interest rates. In the first release of the day, the Commerce Department said that personal income, the fuel for consumer spending, rose in July by 0.5%, the largest increase since March. Personal consumption expenditures (PCE or consumer spending) rose by 0.4%, up from a 0.2% increase in June (originally reported as 0.1%). While the gains were a bit higher than analysts had predicted, both readings were right in line with the monthly averages of the previous twelve months.
Later, in a separate report, the Commerce Department said that the seasonally adjusted level of factory orders rose in July by 3.7%. The rise was the largest in four months and June's originally reported increase of 0.6% was revised up to 1.0%. Analysts had predicted an increase of between 3.0% and 3.5% due to last week's reported increase of 5.9% in durable goods orders. In today's report, the increase in the durables category was revised up to 6.0%. Nondurable goods orders rose by 1.3%.
The volatile transportation sector was a large contributor to the overall gain. Orders there were up by 11.0%. But even excluding the category, orders rose last month by 2.4% following a 0.4% ex-transportation decline in June. Another significant category orders excluding those in the defense sector because defense needs are not governed by standard market forces. While defense orders soared by 31.5% in July, the biggest jump since last November, orders outside the category still increased by 3.2%. And even if commercial aircraft orders are further excluded from the ex-defense category, orders were still up by 2.7%.
Interested observers also look at the category of ex-defense capital goods minus aircraft since it provides a gauge of core business demand on the manufacturing process. Orders there rose by 1.7% last month following a 0.2% decline in June and a 1.5% decline in May.
In other news, the Chicago branch of the National Association of Purchasing Management (now known nationally as the Institute for Supply Management) released its index figures on the highly-industrialized region's manufacturing activity for August. The overall index came in at 53.8, up from July's reading of 53.4. Any reading over 50.0 reflects a general increase of activity relative to the preceding month and August's index indicated a stronger expansion than the 53.0 that analysts had predicted. The national index for August will be released next Tuesday.
The last economic release of the day was somewhat anticlimactic. According to news sources, the final Consumer Sentiment Index reading for the month from the University of Michigan came in at 83.4, up slightly from the preliminary reading of 83.3. Despite the nominal increase, the index was still down sharply from July's final reading of 90.4. In fact, it was the lowest reading since the final reading in August of 2006. The expectations index slipped in the last half of the month to 73.7 from the preliminary 74.1 and July's final reading of 81.5. But the index of present conditions edged up to 98.7 from 97.7. This was still well
below July's final reading of 104.5.
There are a lot of market influences at play this morning so price movements are likely to be erratic. It is the last day of August so any remaining close-out activity for the month has to happen today. Trading volumes will be light as a number of market participants are already on the sidelines and many who are not will be attempting to get there as soon as possible in order to extend the last holiday weekend of the summer. Most bond trading will close at 2:00 PM Eastern Time instead of 3:00 on the recommendation of the Securities Industry and Financial Markets Association.
