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The Fed chatter on a probable interest rate hike has so far produced a positive reaction in the markets, as it was seen as a signal that the economy may finally be ready to turn the corner. However, none of the Fed speakers have given a timeframe as to when the ultra loose monetary policy could be ditched in favor of a more restrictive policy. The lack of conviction over a timetable to abandon the Fed's zero interest rate policy is primarily due to fluid labor market conditions.
Since January 2008, the economy has been losing jobs, but the consolation has been that the pace of firings has slowed down from a rate of 742,000 in January 2009 to a mere 263,000 in September 2009. All said and done, cumulatively the economy has lost 7.21 million jobs in the recent downcyle and the unemployment rate has climbed up to 9.8%. Commerzbank points to the fact that in the past the Fed has hiked rates after the unemployment rate has peaked and has shown signs of a sustainable decline.
The firm is of the view that it is at this stage that a self-perpetuating cycle in which higher employment = higher income = higher consumption = higher production = higher employment has been set in motion. Additionally, it is at this stage that a shortage of labor begins to develop and inflationary threat increases. This time around, the decision 'to hike' or 'not hike' isn't that easy, as the central bank has pursued a highly expansionary policy, which calls for even greater expansionary policy measures if the economy does not improve as expected. Also, the durability of the recovery is in doubt, given the fragility of the improvement seen in the various sectors of the economy.
Equally important are inflation expectations that have a greater role to play in determining monetary policy. If inflation expectations rise along with a rise in bond yields, the central bank will be left with no other option, but to tighten rates. However, this scenario is unlikely to develop at least in the near term.
The most likely policy course could be a move towards tightening rates, although not to restrictive levels, by the middle of 2010, when the unemployment rate begins to recede from its peak. BMO Capital Markets believes that the Fed will stay pat until next September, as core consumer price inflation rate will continue to trend lower due to declines in rents and real wages.
Reflecting the cloudy outlook, the past week's data was mixed. In September, industrial production rose a better-than-expected 0.7%, while economists had expected a mere 0.2% increase in output. On a more positive note, the previous month's reading was revised up to show industrial production growth of 1.2% compared to the 0.8% growth estimated initially. Capacity utilization rose 0.6 percentage points to 70.5%, marking the highest reading since February. The strong reading was made possible by an 8.1% increase in the output of motor vehicle and parts as auto plants ramped up to fill depleted inventory levels.
The retail sales report for September also painted a fairly positive picture, showing a strong underlying trend. Retail sale fell 1.5% month-over-month, better than forecasts for a 2.1% decline. Excluding auto sales, retail sales were up 0.5%, a bigger increase than the 0.2% growth expected by economists. Most sectors, barring building materials and garden equipment suppliers and online stores, reported sales growth, which suggest that sales received a boost from a late Labor Day.
The results of the two manufacturing surveys released suggested expansion in the sector, although the degree of expansion relayed by the surveys presented a mixed picture.
The Philadelphia Fed's survey showed that the manufacturing index fell to 11.5 in October from 14.1 in September. The new orders index rose 3 points to 6.2, marking the highest level since December 2007 and the employment index climbed to -6.8 in October from -14.3 in the previous month. However, the inventories index fell 13.7 points to -31.8.
On the other hand, the Empire State survey's manufacturing index jumped to 34.6 in October, rising to its highest level since May 2004. The new orders index and the order backlogs index rose 12 points and 6 points, respectively. The employment index moved into positive territory for the first time since June 2008, rising to 10.4 in October from -8.3 in September. The 6-month future business conditions index rose 4 points to its highest level since November 2004.
At the same time, the weekly jobs report showed that initial jobless claims fell to 514,000 in the week ended October 10th, dropping to their lowest levels since early January. Continuing claims also declined, while those receiving emergency unemployment compensation increased by 10,000 and those getting extended benefits rose by 6,000.
Meanwhile, the Commerce Department said business inventories fell 1.5% month-over-month in August compared to expectations for a 1% drop. Business sales rose 1% and consequently, the business inventories to sales ratio fell to 1.33 in August from 1.36 in the year-ago period. Following the bigger than expected drop in inventories, third quarter GDP growth may be revised down slightly. However, this could be viewed in a positive light, as depleted inventory levels provide scope for increased economic activity when inventory rebuilding begins.
The minutes of the August FOMC meeting released last week showed that the policymakers believe that the economy is improving. The members commented that overall economic activity was beginning to pick up, with factory output and consumer spending rising due to government rebate and dealer incentives. Investment is stabilizing and the pace of job losses is slowing. The committee remained hopeful that inflation would be reined in due to weak labor markets and significant underutilization of resources.
The consumer price inflation report showed that the monthly consumer price inflation rate as well as the core consumer price inflation rate were both at 0.2% in September. On a year-over-year basis, core consumer prices rose 1.5%.
Consumer sentiment data was not enterprising, as the preliminary reading of the University of Michigan's consumer sentiment index fell to 69.4 in October from 73.5 in September. The decline was mainly due to the outlook index, which fell 5.9 points to 67.5, while the current conditions index slipped by 1.3 points.
The housing market is likely to be in focus in the unfolding week, as we get incremental news flow on the sector amid signs of stabilization. Traders may closely watch the Commerce Department's housing starts report for September, the National Association of Homebuilders' housing market index for October and the National Association of Realtors' existing home sales report for September. Additionally, the spotlight will be on the Fed speeches scheduled to be delivered during the week, including the ones by Federal Reserve Chairman Ben Bernanke.
The results of the Treasury's 52-week bill auction (due to be announced at 1 PM ET on Tuesday) and 2-year note auction, 5-year note auction, 5-year TIPS auction and 7-year note auction (all due to be announced at 11 AM ET on Thursday) could also prove market moving. Some degree of attention is also likely to be vested on the Labor Department's jobless claims report, the Conference Board's leading indicators index for September, the Labor Department's producer price index for September and the Federal Reserve's Beige Book.
Notwithstanding a flat trend witnessed in single-family permits in August, housing starts as well as permits may have increased in September, primarily due to new home inventories dropping to their lowest level since 1983.
Going by the pending home sales index, which has been rising in each of the past seven months, existing home sales is expected to show an increase in September. Sales are likely to stay afloat, aided by the first time homebuyers' credit. Unless the credit is extended, there is a risk that the sales gains are reversed in 2010.
Producer prices are likely to have seen a drag from lower gasoline and natural gas prices. Food prices are also expected to show a softening trend. Accordingly, the consensus estimates call for a no change in headline producer prices, although the core reading is likely to have seen an uptick.
The Fed's Beige Book is expected to show cautious optimism, with the report likely to make a note of an improvement in consumer spending, excluding autos, residential real estate and manufacturing. The improvement in financial market conditions may have sown the seed for an eventual recovery in the credit markets. However, the Beige Book is likely to show the continuing turmoil in the commercial real estate market.
Monday
The National Association of Homebuilders is scheduled to release the results of their survey on homebuilders' confidence at 1 PM ET.
The housing market index rose for the third straight month in September, rising 1 point to 19. While the index measuring current sales conditions rose 2 points to 18, the index gauging sales expectations fell a point to 29. At the same time, the index measuring traffic of prospective buyer traffic rose a point to 17.
Bernanke is scheduled to speak at a San Francisco Fed conference on 'Asia and the Global Financial Crisis' in Santa Barbara, California.
Tuesday
A report on housing starts, which refer to the number of privately-owned new homes on which construction has been started over some period, and building permits, which are the number of permits issued for new housing units each month, is slated to be released at 8:30 AM ET. Economists estimate housing starts of 610,000 for September.
In August, housing starts rose 1.5% month-over-month to 598,000 from an upwardly revised reading of 589,000 in July. Economists had expected housing starts to have risen to 583,000 from the initially estimated reading of 581,000 for July.
Single-family starts rose 3%, while starts of buildings with five units or more were 115,000. Annually, housing starts slumped 37.7%. Building permits fell 2.7% month-over-month to 579,000.
The U.S. Labor Department is scheduled to release its report on the producer price index for September at 8:30 AM ET. The index measures the average change over time in the prices received by domestic producers of goods and services. Economists expect the headline index to have remained unchanged and the core index to show 0.1%growth.
In August, the producer price index rose 1.7% month-over-month. The decrease followed a 0.9% decline in July. Economists had estimated a 0.8% growth. Core producer prices rose 0.2%, slightly more than the 0.1% increase expected by economists.
Food prices rose 0.4% compared to an 8% jump in energy prices. Inflation in the pipeline seems to be picking up, as the intermediate food and energy prices rose 0.3% and 7.1%, respectively.
Philadelphia Federal Reserve Bank President Charles Plosser is scheduled to speak on monetary policy in a tough environment to the Standford Institute for Economic Policy Research in Palo Alto, California at 8 PM ET.
Wednesday
The Energy Information Administration is scheduled to release its weekly petroleum inventory report for the week ended October 16th at 10:30 AM ET.
In the week ended October 9th, gasoline inventories fell by 5.2 million barrels, 2009, but yet were just above the upper limit of the average range.
Distillate fuel inventories fell by 1.1 million barrels, although they remained above the upper boundary of the average range. However, crude oil inventories rose by 0.4 million barrels, remaining above the upper boundary of the average range. Refinery capacity utilization averaged 84% over the four weeks ended October 9th compared to 85.5% in the previous week.
The Federal Reserve is due to release its Beige Book, which is a compilation of anecdotal evidence on economic conditions from each of the 12 Federal Reserve districts, at 2 PM ET. The report is normally released about two weeks before the monetary policy meeting is held.
Boston Federal Reserve Bank President Eric Rosengren is due to open the Boston Fed's annual Cape Cod economic conference in Chatham, Massachusetts on re-evaluating regulatory and monetary policy at 4:30 PM ET.
Thursday
The Labor Department is due to release its customary jobless claims report for the week ended October 17that 8:30 AM ET. Economists expect a slight rise in claims to 517,000.
First-time claims for unemployment benefits decreased by a little more than economists had been expecting in the week ended October 10th. Jobless claims fell to 514,000 from the previous week's revised figure of 524,000. Economists had been expecting jobless claims to edge down to 520,000 from the 521,000 originally reported for the previous week.
The Conference Board is scheduled to release a report on the U.S. leading index for September at 10 AM ET. The consensus estimate calls for a 0.9% increase in the leading indicators index for the month.
The leading indicators index rose for the fifth straight month in August. The index rose 0.6%, a tad below the expected growth of 0.7%. However, the previous month's growth was revised upwards by three tenths of a percentage points to 0.9%. Interest rate spread, stock prices and the pace of deliveries were the strongest positive contributors to the index, while the M2 money supply served as the biggest drag. While the coincident economic index was unchanged in August, the lagging economic index eased 0.1%.
Rosengren is also scheduled to present a paper to the Boston Fed's annual Cape Cod conference in Chatham, Massachusetts on whether financial stability should be added to central banks objective at 10:30 AM ET.
New York Federal Reserve Bank President William Dudley would moderate a panel on monetary policy instruments and the Fed's supervisory function, at the Boston Fed's Cape Cod conference in Chatham, Massachusetts at 1:30 PM ET.
Friday
Bernanke is due to speak on the supervisory landscape at the Boston Fed's Cape Cod conference in Chatham, Massachusetts at 8:30 AM ET.
The National Association of Realtors is scheduled to release its report on existing home sales for September at 10 AM ET. Economists estimate existing home sales of 5.35 million for the month.
Existing home sales fell 2.7% month-over-month to a seasonally adjusted annual rate of 5.1 million units in August compared to 5.24 million in July. However, annually, existing home sales were 3.4% higher. About 30% of the buyers were first time buyers and 31% of the sales were distressed.
The median sales price of an existing home was at $177,700, down 12.5% year-over-year and 2.1% lower than in the previous month. Inventories measured in terms of months supply fell to 8.5 in August from 9.3 in the previous month, with the metric now at its lowest levels since April 2007.
Federal Reserve Vice Chairman Donald Kohn would participate in a panel discussion on international perspectives at the Boston Fed's Cape Cod conference in Chatham, Massachusetts at 11:30 AM ET.
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