Vital Signs: How Low Will the Fed Go?

On tap: The Federal Reserve's monetary policy meeting, November figures on industrial output, inflation, and retail sales, October foreign trade data

When the Federal Reserve lowered interest rates at the end of October, many investors didn't think the central bank was finished cutting. Even after Federal Reserve Governor Randall Kroszner said on Nov. 16 that "current stance of monetary policy should help the economy get through the rough patch during the next year," investors increasingly expected a rate cut at the Dec. 11 monetary policy meeting.

Now, the Fed appears to be coming around to the financial market's view of the world in light of additional credit market tightening and soft economic data. In a Nov. 29 speech, Chairman Ben Bernanke's description of economic and financial conditions bolstered expectations of a rate cut.

Indeed, the topic du jour went from if the Fed would act, to how much would interest rates be reduced. According to trading data on Fed futures contracts compiled by Bloomberg Financial Markets, the implied odds of some kind of rate cut are 100%, with the breakout at 58% for a quarter-point cut and 42% for a half-point reduction.

The reason Bernanke and other Fed officials exited the October policy meeting sounding so reluctant to cut again was the concern over inflation. When the November price data come out this week, expect bigger numbers driven by higher oil and other energy costs.

However, if this week's collection of data on economic activity proves to be soft, the threat of higher inflation will continue to diminish in the eyes of investors and private economists. Weaker consumer spending, especially outside of gasoline and housing-related purchases, and a slowdown in factory output could raise already rising expectations that economic growth in the fourth quarter could fail to reach 1%. At that rate, slack in the economy would quickly emerge and price pressures on goods and labor would ease.

Of course, further evidence of cracks in the U.S. economy would also crank up WallStreet's expectations of more Fed rate cutting in January.

Here's the weekly economic calendar, from Action Economics.

Economic Reports
Report Date Time For Median Estimate Last Period
Wholesale Trade Sales Tuesday, Dec. 11 10:00 a.m. October 0.4% 1.3%
Trade Balance (billion) Wednesday, Dec. 12 8:30 a.m. October -$57.1 -$56.5
Export Price Index Wednesday, Dec. 12 8:30 a.m. November 0.4% 0.9%
Import Price Index Wednesday, Dec. 12 8:30 a.m. November 1.8% 1.8%
Treasury Budget (billion) Wednesday, Dec. 12 2:00 p.m. November -$70.0 -$55.6
Retail Sales Thursday, Dec. 13 8:30 a.m. November 0.5% 0.2%
Retail Sales (ex-auto) Thursday, Dec. 13 8:30 a.m. November 0.6% 0.2%
PPI Thursday, Dec. 13 8:30 a.m. November 1.0% 0.1%
PPI (ex-food & energy) Thursday, Dec. 13 8:30 a.m. November 0.2% 0.0%
Business Inventories Thursday, Dec. 13 10:00 a.m. October 0.4% 0.4%
CPI Friday, Dec. 14 8:30 a.m. November 0.5% 0.3%
CPI (ex-food & energy) Friday, Dec. 14 8:30 a.m. November 0.2% 0.2%
Industrial Production Friday, Dec 14 9:15 a.m. November 0.2% -0.5%
Capacity Utilization Friday, Dec. 14 9:15 a.m. November 81.7% 81.7%

PENDING HOME SALES - Monday, Dec. 10, 10 a.m. EST

The National Association of Realtors index of pending home sales tracks purchase activity by looking at signed real estate contracts for existing residences. The index is viewed as a leading indicator of existing home sales.

The October figures come out on Dec. 10, after the overall September index stayed pretty flat, rising just 0.2% from August. However, there was some variation across the four main regions with the Northeast posting a 10.1% drop and the Midwest up 5.4% on a monthly basis.

On a yearly basis, pending home sales were off 20.4%, slightly better than the 21.5% decline of August. That's in line with the 20.7% drop in actual existing home sales. Another leg downward in the pending sales index would stir up deeper concerns about the housing market's decline and its ability to pull down the rest of the economy.


Tuesday, Dec. 11, 9 a.m. EST - The Federal Reserve's Federal Open Market Committee will discuss monetary policy. An announcement by the Fed will come around 2:15 p.m. Just about every private economist believes the central bank will cut its target fed funds rate from the current 4.5% level. The big question among Fed watchers is whether Chairman Ben Bernanke and company will cut by 25 or 50 basis points.

Back in October, the Fed stated its rate cut "should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time." The central bankers also expressed a belief that 75 basis points of cutting should do the trick.

However, since then, the financial markets are once again showing signs of constricted credit markets. Spreads between commercial lending rates and risk free Treasury securities have widened and lenders have said they're getting more cautious about who they lend to. In addition, banks are still taking big write downs and charges on their subprime mortages.

The renewed credit concerns have prompted Fed officials, including Bernanke, to express renewed concerns about the health of the economy and financial markets in recent days. These speeches have simply raised expectations for a rate cut among investors.

ICSC-UBS STORE SALES - Tuesday, Dec. 11, 7:45 a.m. EST

This weekly tracking of retail sales, compiled by the International Council of Shopping Centers and UBS bank, will update buying activity for the week ended Dec. 8. Sales plunged 2% in the week ended Dec. 1, after a 0.1% slip in the week ended Nov. 24, which included the busy post-Thanksgiving kickoff to the holiday shopping season. In the prior week sales were up 0.8%. Despite the large weekly decline, sales picked up to a yearly pace of 3.1%, from 2.5%in the week ended Nov. 24.

These numbers reflect a soft start to the holiday shopping season. However, in recent years a larger share of holiday shopping has been occurring later in December as consumers hold out for larger discounts.

JOHNSON REDBOOK INDEX - Tuesday, Dec. 11, 8:55 a.m. EST

This weekly measure of retail activity will report on sales for the first fiscal week of November, ending Dec. 8. For the full month of November, sales were up 0.3%. Sales in October were off 0.4%.


Tuesday, Dec. 11, 10 a.m. EST

Wholesale sales in October probably slowed as economic growth also shows signs of decelerating. In September, sales rose 1.3%, after a 0.8% gain in August. However, the October gain is expected to be far smaller.

In addition, the sales tally could be propped up by higher costs for petroleum. The report shows the dollar value of sales and not the volume. With petroleum prices rising more than 10% in October, the value of October sales is also likely to increase. Economists will be focusing on how sales do in the durable goods area to see if consumers and businesses are scaling back on purchase of big ticket items.

Inventories have also been climbing, but the pace is still in line with demand. In September, stockpiles were up 0.8%, after a 0.7% rise the month before and a 0.2% increase in July. On a yearly basis, the increase was 5.2% in September. That was below the 9.9% climb in sales.

The September inventory-to-sales ratio was 1.10, down from 1.11 in August and 1.15 a year ago. A lean level of inventories should help limit any potential cutbacks in production that businesses may need to make as the economy cools down.

MORTGAGE APPLICATIONS - Wednesday, Dec. 12, 7 a.m. EST

The Mortgage Bankers Association releases its mortgage Weekly Mortgage Applications Survey of home buying and refinancing application activity for the week ending Dec. 7. Applications have shot up on lower interest rates. The average interest rate for a 30-year fixed-rate mortgage plunged to 5.82%, from 6.09% for the week of Nov. 23.

The purchase index jumped 15.2% to a reading of 464.3, from a downwardly revised 403.2. The prior week's reading was originally 450.1 and was lowered due to an error by one of the reporting companies. Meanwhile, the refi index surged 31.9%, to 2761.3, from an upwardly revised 2093 in the period ended Nov. 23. The originally reported refi index level was 1862.9.

The four-week moving average for the refi index climbed to 2342.5, from 2196.2 during the week ended Nov. 23. The moving average for the purchase index rose to 431 from 418.2 in the prior period.

INTERNATIONAL TRADE - Wednesday, Dec. 12, 8:30 a.m. EST

The October U.S. trade deficit of goods and services probably widened a little, after the September trade gap unexpectedly narrowed to $55.6 billon. A rise in oil prices is expected to lift the nominal value of imported petroleum and petroleum products. The forecast rise in imports will likely prove larger than the rise in exports.

Economists expect the growth in consumer and business spending to wane this quarter and into early 2008. That raises the importance of foreign trade in the overall U.S. economic picture. In the third quarter, a narrowing trade gap accounted for over a quarter of the economy's 4.9% annualized rate of growth. During the July through September period, the inflation adjusted level of exports shot up by an annualized pace of 18.9% -- more than four times as fast as imports.

If the global economy can weather the slowdown in the U.S. fairly well, then the trade gap should keep narrowing. Import growth would likely ease even more as Americans purchase fewer foreign goods. And a weaker dollar would continue to make U.S. products more attractive in foreign currency terms.

IMPORT AND EXPORT PRICES - Wednesday, Dec. 12, 8:30 a.m. EST

The ongoing surge in oil prices pushed up the November import price index. In October, the index jumped 1.8%, the biggest gain since May of 2006, as the prices of imported petroleum zoomed up 6.9%. The cost of non-petroleum imports also rose 0.5%, but the increase was energy related, as natural gas prices climbed 11.1%. Food prices also kept marching upward, posting a 1% monthly gain in October.

On a yearly basis, import prices have shot up 9.6%, driven by a 41.4% surge in petroleum costs and a 9.8% gain in food prices. In other important categories, such as consumer and capital goods, prices continue to climb at a far slower pace.

Export prices are expected to grow at a more modest pace in November, after shooting up by 0.9% in October. There was another large increase in food prices, up 3.9%. But outside of agricultural products, export prices climbed 0.5% as costs of U.S. petroleum and other energy related goods got costlier.

U.S. businesses in general are upping their prices and that's related to the falling dollar. If U.S. businesses don't change the prices of their goods in dollar terms as the currency weakens, those products become cheaper in foreign currency terms. Right now it appears that companies are upping prices some, but not enough to fully offset the weakening in the currency. For example, the prices of consumer goods exports are up 2.5% from a year ago, while the trade-weighted dollar is off about 8%. The numbers may be reflecting different strategies among businesses to either boost revenues by raising the dollar price or go for market share abroad by holding the line.


Wednesday, Dec. 12, 2 p.m. EST

Economists expect the November budget deficit to be a little smaller than it was a year ago. The new fiscal year started with an October deficit of $55.5 billion, exceeding the shortfall of the prior year. It will be tough for the fiscal year 2008 deficit to come in below the surprising fiscal year 2007 total of 162.9 billion.

For one, income tax revenues are not growing as fast. The source of the slowdown is corporate income tax receipts which in the past 12 months through October were up just 2.7% vs. the prior 12-month period. That's the smallest increase since September of 2003. Individual income taxes were up 11.1%. However, if a weaker economy means softer job growth and slower wage gains, the windfall from individual receipts will also taper off.

JOBLESS CLAIMS - Thursday, Dec. 13, 8:30 a.m. EST

The number of initial jobless claims retreated to 338,000 for the week ended Dec. 1. In the week ended Nov. 24, claims stood at 353,000, after a reading of 329,000 in the prior period.

The four-week moving average trended higher, to 340,250 for the week ended Dec. 1, from 335,500 the week before. Continuing jobless claims, which run a week behind the initial claims figures, also fell. The latest level was 2.6 million, from 2.66 million in the week ended Nov. 17.

The data do not appear to be reflecting a pickup in firings. Rather, businesses are just not expanding payrolls.

RETAIL SALES - Thursday, Dec. 13, 8:30 a.m. EST

On the surface, November retail sales figures are expected to be pretty solid. Economists surveyed by Action Economics are forecasting a 0.5% increase in spending, after a tepid 0.2% gain in October.

On the plus side, the holiday shopping season appeared to get off to a decent start. Sales during the weekend after Thanksgiving were decent as stores offered big discounts on many items. However, a sizeable part of the November gain is likely to show up in the gasoline station sales category due to higher gas prices.

Wall Street will be looking very closely at figures on consumer spending and sentiment. There's a widespread belief that people are turning more frugal. Consumers are facing a confluence of higher oil prices, falling home prices, and tighter credit conditions. There are also concerns about slower job and wage growth.

If retail sales surprise to the downside, it will raise fears among economists of a major slowdown in economic growth and up the odds of a possible recession.

PRODUCER PRICE INDEX - Thursday, Dec. 13, 8:30 a.m. EST

November producer prices for finished goods are expected to jump on higher energy costs. In October, the index rose just 0.1% due to a 0.8% drop in energy costs and a 2.7% fall in truck prices. Within energy, the decline was driven by a 3.1% fall in gasoline prices, but that will turn around in the November report. The cost of food increased 1% in October, while prices outside of food and energy were flat.

On a yearly basis, businesses have seen price increases accelerate, even outside of food and energy. The overall index was up 6.1% from a year ago in October, the biggest jump in two years. Core producer prices were up 2.5%, also a two-year high.

However, it still appears as if businesses are absorbing most of the price gains in energy and other goods. Looking at crude goods prices, which includes mostly raw materials not sold to consumers, the yearly increase was 25.7% in October. Outside of food and energy the gain was 18.6%.

If economic growth slows, it will be even harder for businesses to pass along the higher costs of commodities and other inputs to other businesses and consumers.

BUSINESS INVENTORIES - Thursday, Dec. 13, 10:00 a.m. EST

Business inventories probably grew at a pretty benign pace in October. Already, manufacturers reported a small increase of 0.1%. Economists will be watching the inventory data for larger-than-expected increases because it's a potential indicator of a slowing economy.

In September, stockpiles grew 0.4%, after a 0.3% August gain. Based on the inventory-to-sales ratio, the pace of inventory growth looks well in line with demand. The ratio showed enough inventories to cover 1.27 months worth of sales, an historically low number.

CONSUMER PRICE INDEX - Friday, Dec. 14, 8:30 a.m. EST

Inflation probably picked up in November -- with energy prices the culprit once again. The consensus among economists calls for a 0.5% monthly rise in November, after a 0.3% increases in both October and September. Energy prices rose 1.4% in October and could post an even bigger increase in November.

If economists are on target with their November forecast, the yearly rate of inflation would accelerate from the October pace of 3.5%. Last November, the monthly CPI fell 0.1% as energy prices slid in the latter stages of the year.

Price increases outside the volatile food and energy are expected to be more subdued than the headline reading, with economists forecasting a November gain of 0.2%. It would mark the sixth straight monthly gain of 0.2%.

On a yearly basis, core inflation had been easing, but may now be leveling off. The yearly pace in October was 2.2%, up from 2.1% in each of the prior two months but below the 2.6% tempo of a year ago. The price gains in medical care, education, and recreation are lifting the pace of core inflation.

However, the rise in inflation may not last long if expectations of slower economic growth come to fruition. A lower pace of economic growth would likely cause more unemployment, a lower capacity utilization rate in manufacturing, weaker wage growth, and even less pricing power ability among businesses. This is why the Fed may be less concerned about inflation in the short to medium term at its Dec. 11 monetary policy meeting, despite the currently elevated figures.

REAL EARNINGS - Friday, Dec. 14, 8:30 a.m. EST

Inflation-adjusted weekly earnings of production workers most likely retreated in November. That's based on the consensus forecast of a 0.5% gain in consumer prices and the expected 0.3% gain in average weekly earnings for the same month. Real earnings slipped 0.2% in October, after holding steady the month before.

The growth in inflation-adjusted earnings is losing steam. On a yearly basis, real earnings were down 0.3% in October, after a 1.2% rise in September and a 2.1% jump in August.

INDUSTRIAL PRODUCTION - Friday, Dec. 14, 9:15 a.m. EST

Industrial activity is expected to post a small increase in November. The forecast rise would follow a 0.5% drop in October. Manufacturing output fell 0.4%, while utility production dropped 1.6% on seasonally mild temperatures.

Weakness in factory payrolls, a fall in new orders, and another soft reading in the Institute for Supply Management's November factory activity report all point to a continued slowdown in factory production. On a yearly basis, industrial production cooled off to 1.8% in October, from 2.1% in September, and 4.6% last October.

The primary culprit behind the moderation in manufacturing activity is the auto industry. Motor vehicle output dropped 1% in October, a third straight monthly decline. Housing related areas, such as furniture and construction material, have also been soft. And the slowdown in activity may be spreading. Machinery production fell for a second month out of three in October.

The deceleration in activity has opened up some slack in production capacity, possibly easing price pressure concerns. The October capacity utilization rate fell to 81.7%, from 82.2% in September. Strictly among manufacturers, the October utilization rate eased to 80.1%, from 80.5% the month before.

Earnings Calendar
Day Companies
Monday H&R Block, Pall
Tuesday Kroger
Wednesday Martek Biosciences
Thursday Costco Wholesale, Lehman Brothers
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