5:00 PM EST :Treasuries tanked today but the catalyst was not the stock market since the indices barely moved. A number of market commentators blame today's solid employment report for dimmed any expectations of a half-point rate cut by the Fed next week. In late trading, the 10-Year Treasury Note was down by 26/32, raising its yield to 4.11%; the Dow was up by 5.69 points to 13,625.58; and the Nasdaq was down by 2.87 points to 2,706.16.
Nonfarm payrolls rose more than the forecasts of a couple days ago. But recent speculation had observers looking for a strong report and bonds lost considerable ground on Wednesday and Thursday because of those concerns. Apparently, the preparation was inadequate and Treasuries took an even larger plunge today.
The other economic news of the day was bond-friendly but failed to make an impression on the market. The preliminary read on consumer sentiment for the month reflected the lowest level of optimism in two years.
The jobs news did not spark a rally in stocks. Nor did a retreat in oil futures today. The price of a barrel of light, sweet crude oil for next month delivery falling by $1.95 on the New York Mercantile Exchange to settle at $88.28. After Wednesday's close of $87.49, this was the second lowest for a front-month contract since October 24.
By the end of stock trading, the Dow posted a nominal gain on the day of 0.04%, the S&P 500 slipped by 0.18%, and the Nasdaq lost 0.11%. Despite today's performance, all three indices made good gains for the week. The Dow rose by 1.90%, the S&P 500 by 1.59%, and the Nasdaq by 1.70%. In contrast, the yield of the benchmark 10-Year Treasury Note rose by 17 basis points following five consecutive weeks of declines. Yields rise when the price falls. Today's closing yield was the highest since November 16.
Next week has a heavy slate of market influences but it starts off on Monday with only one major economic release. This is the report on pending home sales from the National Association of Realtors and the report is of secondary importance since its value is as an indication of subsequent, actual home sales that will be reported later this month.
The report for September said that the NAR's seasonally adjusted index of pending home sales rose by 0.2% that month, although forecasters were looking for a decline of 1.0% or 2.0%. Yet, the improvement is only modestly bullish as it comes off a record low in August.
The data series was first published in 2005 with data going back to 2001. The index is a measure of contract activity and the NAR asserts that 80% of contracts become sales within two months and a large portion of the rest, two months thereafter.
On Tuesday morning, trade is apt to be subdued as participants await the results of the day's meeting of the Federal Open Market Committee (FOMC), the central bank's monetary policy arm. There is only one major economic release in the morning and it will probably get scant attention. This is the report on wholesale inventories for October.
Even without the FOMC meeting, the release is not usually a market-mover since the data is somewhat dated and it does not give a complete overview of the inventory situation (last Wednesday's factory orders report revealed levels of manufacturer inventories, but the situation in the retail sector is still missing).
The report for September was more bullish than expected. The Commerce Department reported that the seasonally adjusted level of wholesale inventories rose by 0.8%. Not only was this much higher than the 0.1% that forecasters had predicted, but August's originally reported gain of 0.1% was revised up to an increase of 0.7%.
Rising inventories are often a bullish indicator since they may represent efforts to stock up for rising demand. And September's report showed that demand was strong then with sales rising by 1.3%. August's originally reported increase of 0.4% was revised to 0.8%.
The combination of inventory levels and sales produced a record low inventory-to-sales (I/S) ratio of 1.10. The I/S ratio is the value of stocks on hand at the end of a month divided by the value of sales for the month. It indicates how many months it would take to entirely deplete existing inventory at the prevailing sales pace. A low figure indicates high turnover and high pressure to replenish supplies.
For October, wholesale inventory levels are expected to have risen by about 0.5%.
The FOMC policy statement will be released at about 2:15 PM Eastern Time. Most observers are expecting the committee to cut its target for the overnight borrowing rate between banks (federal funds rate) and the rate banks must pay for loans directly from the Fed (discount rate).
Between June of last year through early August of this year, the Fed took no rate action but maintained a slightly hawkish (that is, tightening) bias, citing elevated core inflation and concerns that it might not abate as expected. But the troubled housing and mortgage industries began to obstruct credit flows since investors backed away from risky mortgage debt, thereby eroding its value. Consequently, lenders in general tightened loan standards, making it harder to borrow money. In the meantime, holders of mortgage loan products have suffered losses since buyers are scarce. This bottleneck reduces the amount of money flowing through the monetary system and drives up the cost of borrowing.
With the complex network of risk-sharing in the world markets, the credit troubles spread and the Fed finally stepped in and made an emergency 0.50% cut to the discount rate in August. This brought the rate down from 6.25% to 5.75%. In addition, the committee extended the length of time reserves could be borrowed and it made a public relations push to diminish the negative connotations attached to such borrowing (loans from the Fed were typically considered last resort measures).
Nevertheless, short-term commercial debt offerings dried up and investors flocked to the safety of government backed securities. In order to ease the credit situation, the Fed decided in its September meeting to cut the fed funds rate by 0.50%, from 5.25% to 4.75%. This was the first rate cut since June of 2003 and the largest since November of 2002. The policy committee also cut the discount rate again by 0.50% from 5.75% to 5.25%.
Then, in October's meeting, the committee cut both rates once more but by 0.25%, bringing the fed funds rate down to 4.50% and the discount rate to 5.00%. But October's policy statement seemed to indicate that the actions taken since August should be enough to offset the flagging economy. "The Committee judges that, after [the latest] action, the upside risks to inflation roughly balance the downside risks to growth."
Another aspect of the meeting that unnerved some bond traders was the fact that the rate cut decision was not unanimous. Kansas City Fed President, Thomas Hoenig, voted against it.
But the Chairman of the Federal Reserve, Ben Bernanke, raised expectations for another cut last month. In congressional testimony, he laid out the Fed's economic projections. He said, "Growth was seen [by the monetary policy committee at the last meeting] as remaining sluggish during the first part of next year, then strengthening as the effects of tighter credit and the housing correction began to wane."
However, he noted the possibility that the economy might not recover as expected. "Should the rate of foreclosure rise proportionately, communities as well as individual borrowers would be hurt because concentrations of foreclosures tend to reduce property values in surrounding areas. A sharp increase in foreclosed properties for sale could also weaken the already struggling housing market and thus, potentially, the broader economy."
While this seemed to hint that more monetary accommodation was in the works, the thrust of the argument was blunted somewhat by the threat of inflation. Mr. Bernanke said that though price stability is expected to remain within acceptable limits, high price of oil and other commodities, along with the weak dollar, could boost overall inflation.
A stronger than expected revision to third quarter gross domestic product and today's relatively strong employment report have also weakened the rate cut argument. Furthermore, yesterday's official unveiling of a plan to cushion the fallout rate of subprime mortgage loans has reduced the expected impact on the economy and credit market from the housing situation.
Currently, though, Fed watchers still believe that the policy committee will cut the fed funds and discount rates again by 0.25% when it meets next Tuesday.
Wednesday brings a couple of trade-related reports. The main one is the report on international trade for October, the first month of the fourth-quarter. In the last report, the Commerce Department said that the seasonally adjusted value of imports exceeded that of exports by $56.5 billion in September. The deficit figure was much lower than the $58.0 billion that analysts had predicted. Moreover, August's originally reported trade gap of $57.6 billion was revised to a deficit of $56.8 billion.
The deficit figures have narrowed in each of the last four report months and in five of the last six. The latest was the lowest since May of 2005. The declining value of the dollar is the primary reason. The weaker dollar makes U.S. goods cheaper to foreign buyers, thereby boosting sales.
The trade report said the value of imports rose in September by 0.6% but this followed a 0.7% decline in August. Exports rose by 1.1%, the seventh consecutive increase. The value of exports was a record high and the value of imports was at its second highest monthly level.
For October, analysts foresee only a slightly wider monthly gap of about $57.0 billion.
The other release on Wednesday morning is the report on import and export prices for November. In the last report, the Labor Department said its seasonally adjusted index of import prices rose by 1.8% in October, the largest jump since May of 2006. Forecasters had been expecting a rise of about 0.8%. The fact that September's originally reported increase of 1.0% was trimmed to 0.8% did not cushion their surprise.
As expected, the largest contributor to the increases has been from petroleum products. The index for that sector rose by 6.9% in September, the largest since last March. Yet, even excluding petroleum, prices were up by 0.5%, the biggest increase since last May. Ex-petroleum prices were down by 0.2% in September and were unchanged (0.0%) in August.
The report said that export prices were up by 0.9% last month, the largest increase since April of 1995. A large but volatile export category is agricultural products and its price index was up by 3.9% following a 4.1% increase in September. Excluding the category, prices were up by 0.5%, the largest increase in six months.
Oil prices surged last month so forecasters are looking for another jump in the overall import price index of 2.0%. This would be the largest increase since April of 2006.
On Wednesday afternoon, the Treasury will release its budget figures for last month. In November of 2006, outlays exceeded receipts by $75.6 billion. Forecasts for last month call for a slightly smaller deficit of $75.0 billion. This would bring the total for the first two months of the 2008 fiscal year to a deficit of $130.6 billion, a deeper shortfall than the $122.4 billion of the first two months of the 2007 fiscal year. Higher deficit figures are a negative for bonds since they mean the Treasury will not have to issue more debt securities (Treasuries) in the future.
On Thursday, the jobless claims report will once again address the employment situation. In yesterday's report, the Labor Department said the seasonally adjusted level of initial claims for state unemployment benefits fell last week by 15,000 to 338,000. The decline was not unexpected as the data series has been swinging back and forth lately with a rise of 24,000 in the week of November 24, a decline of 12,000 in the week of November 17, and a rise of 22,000 in the week of November 10.
Despite the latest move, the recent underlying trend has been up. The four-week moving average, which smoothes out some of the short-term volatility, rose last week by 4,750 to 340,250, the highest reading in over a year. The average weekly claims figure for the year to date is 320,354. For 2006, the average was 312,962. The rising claims levels suggest a slack labor market, but any reading below 400,000 is generally considered a sign that hiring is outpacing layoffs.
Yesterday's report said that the level of continuing claims for the week ending November 24 (continuing claims must be at least a week old) fell by 59,000 to 2.599 million. Again, however, the underlying trend has been up. The four-week average rose by just 6,000 to 2,593,750 but this was the highest reading since last January. The average weekly continuing claims level for the year to date is 2,537,064. For 2006, the
average was 2,458,519.
A key inflation indicator comes out on Thursday. This is the Producer Price Index (PPI), a gauge of price changes at the wholesale level. October's report said the index rose by just 0.1% following a 1.1% energy-related spike in September. The index of energy prices fell by 0.8% in October following a 4.1% rise. The headline increase was largely attributable to a 1.0% increase in the index for another volatile
category: foods. Excluding energy and foods, the so-called core index showed virtually no change at all (0.0%). This followed a core increase in September of only 0.1%. Forecasters had predicted an overall PPI increase of 0.2% in October and a same-sized move at the core level.
Another energy-related surge is expected for November with predictions that the overall index rose by 1.5%. But at the core, the index is expected to have risen by just 0.2%.
Another major release on Thursday besides the PPI is the report on retail sales for last month. In October's report, the Commerce Department said the seasonally adjusted level of sales rose by 0.2%. This was in line with forecasts though September's originally reported increase of 0.6% was revised up slightly to 0.7%. Excluding the large but volatile auto category, sales were also up by 0.2%, a slightly weaker gain than analysts had predicted. Furthermore, September's originally reported ex-auto increase of 0.4% was revised down to 0.3%.
For November, forecasters are predicting an overall increase of 0.2% and a 0.5% rise excluding autos.
A little later, the Commerce Department will release its report on business inventories for October. The seasonally adjusted level rose by 0.4% in September. By the time October's report is released, observers will already have a fairly broad view of the inventory situation since the last factory orders report indicated that manufacturers' inventories rose by 0.1% that month and the wholesale inventories report will have been released, which is predicted to show a 0.5% increase.
The only unknown is the retail category. The average monthly change in this category has been an increase of 0.3%. If these values are plugged into the category weightings for the overall business figure, it produces an unremarkable rise of 0.3%.
Another item in the report that will be watched is the inventory-to-sales (I/S) ratio. This is the value of inventories divided by the values of sales for the month. The result shows how many months it would take to entirely deplete the stocks on hand at the prevailing sales pace. A low reading means that pressure is high on the production process to replenish supplies.
Sales increased by 0.6% in September and the combination of factors left the inventory-to-sales (I/S) ratio at 1.27. This was not far from the record low of 1.25. October's ratio is also expected to have remained relatively low.
New supply will be weighing on the bond market on Thursday morning as the Treasury will be auctioning an additional amount of last month's 10-Year Note issue. The arrival of new supply usually keeps bond prices down until the market has a chance to begin digesting the inventory. Traders who will be making bids refrain from pushing prices up prior to an auction in order to keep yields up (bids are for yield -- the higher, the better for the auction participants). Other traders also avoid purchasing the soon-to-be off-the-run issue since the new one will have greater liquidity. They also assume a wait-and-see posture until the results of the sale are known.
In the last such 10-Year Note reopening in September, demand was fairly strong. Bids exceeded the $8 billion offer amount by 2.95 to 1, the highest bid-to-cover ration since the current issue cycle (an initial and reopening auction each quarter) began in 2003. Noncompetitive bids -- a gauge of individual investor demand -- totaled $18 million, which was below the average of $21 million for the twelve reopenings prior to September's.
Foreign demand was strong for a reopening with indirect competitive bids, which include those from foreign central banks, receiving 22.4% of the issue. This was about twice the twelve-reopening average of 11.7%.
Last month's initial issue for the quarter was mixed with a decent bid-to-cover ratio of 2.34 on the $13 billion offering versus the twelve (initial) auction average of 2.30. Noncompetitive bids totaled $137 million versus the twelve auction average of $86 million. However, foreign demand was weak. Indirect competitive bids garnered just 28.2% of the issue, the weakest award for a new 10-Year issue since February of 2005.
Thursday's offering is expected to have a face amount of $8 billion, the same as in the last ten such reopenings. The deadline for competitive bids is 1:00 PM Eastern Time.
On Friday, an even more influential inflation indicator will be released. This is the Consumer Price Index (CPI), a gauge of inflation at the retail level. It rose by 0.3% in October, matching the increase in September. While the monthly release is often a market-mover, October's number was right in line with forecasts.
The largest contributor to the overall advance was a 1.4% rise in the energy category following a 0.3% rise in September. The index in the other volatile category, food, rose by 0.3% following a 0.5% rise in September. Excluding these two categories, the core index was up by 0.2% -- also as expected and also matching September's increase.
Energy is expected to have pushed the overall index up by about 0.6% last month, which if accurate would be the largest jump in six months. But the core index is expected to have risen by 0.2%, making it the sixth consecutive same-sized increase.
The final major economic release of the week is the report on industrial production from the Federal Reserve. Industrial production -- a gauge of output from the nation's factories, mines, and utilities -- fell in October by 0.5%, the largest decline since last January. This followed weak increases in August and September of 0.1% and 0.2%, respectively. And October's weakness was broad-based. The utilities category is usually the most volatile due to weather and, as might be expected, it showed the largest change with a decline of 1.6%. But the largest category, manufacturing, saw a 0.4% drop and mining experienced a decline of 0.6%.
The report said that capacity utilization, the ratio of output to potential output, fell to 81.7% from 82.2% (originally reported as 82.1%). This was the lowest reading since last May. The figure indicates that there is more slack in the production process. Significantly, utilization in the manufacturing sector fell from 80.5% to 80.1%, also the lowest reading since May. More slack translates to a more favorable inflation situation since high utilization can lead to bottlenecks that prevent demand from being met, thereby pushing up prices.
Not much progress is predicted for November with predictions of a 0.1% increase in industrial production. Capacity utilization is expected to have remained at 81.7%.
10:30 AM EST :
Was the employment report too strong or too weak? The stock indices are bobbing around unchanged levels as traders there have yet to make up their minds on the jobs numbers. In contrast, bond traders are looking at the report as a positive assessment of the economy, which reduces the argument for aggressive interest rate cuts by the Federal Reserve. Treasuries began the day underwater and they have fallen further since the release of the employment report.
The Labor Department reported this morning that the seasonally adjusted level of nonfarm payrolls rose in November by 94,000. While this was above last week's predictions of 75,000, it was at the low end of recent predictions of between 90,000 and 150,000.
October's gain was revised up slightly from 166,000 to 170,000 but August's previously reported rise of 93,000 was trimmed to 44,000.
The goods producing sector continued to slide with construction payrolls losing 24,000 last month and manufacturing payrolls, 11,000. In the services sector financial services payrolls fell by 20,000, information services lost 6,000, and utilities lost about 200. The big gainers were professional and business services (+30,000), education and health services (+28,000), and leisure and hospitality services (+26,000). Government payrolls grew by 30,000.
The report said that the unemployment rate, the portion of the active workforce without jobs, remained at 4.7% for a third consecutive month. Forecasters had predicted a slight increase to 4.8%.
One item in the report that provides no support for either stocks or bonds is a jump in average hourly earnings of 0.46%, the highest increase since June. But it follows an exceptionally mild increase in October of 0.06%.
A second-tier economic release was bearish -- normally a plus for bonds, but the news had no impact on the market. According to news sources, the preliminary read on consumer sentiment for the month from the twice-monthly University of Michigan surveys produced an overall index reading of 74.5, its lowest level since October of 2005.
The index of current conditions actually rose to 92.1 from November's 91.5, but projections for the future dimmed with the expectations index falling from 66.2 to 63.2 (also the lowest reading since October of 2005).
Although the bond market's reaction to today's data seems puzzling, traders are also looking ahead to a heavy slate of events next week that includes a Fed policy meeting and a 10-Year Treasury Note auction. The economic release calendar includes the key inflation indicators: the Producer Price Index and the Consumer Price Index. It also includes the monthly retail sales report and the report on industrial production.
