Other economic releases this week include:
- U.S. October existing home sales rose 1.4% over September to annualized 4.96 million units. The months’ supply of unsold homes fell to 8.0 months in October from 8.3 months in September. The median home price fell to $162,500 from $165,800 the month before.
- U.S. third-quarter GDP was revised down to a 2.0% annualized growth rate from the earlier estimated 2.5% rate in the advanced report.
- U.S. October personal income was up 0.4% over September, while consumer spending rose just 0.1%. The saving rate rose to 3.5% in October from 3.3% the month before. The U.S. personal consumption expenditures (PCE) price index fell 0.1% over September.
- October U.S. durable goods orders fell 0.7% over the prior month. Capital goods orders, excluding defense and aircraft, leading indicators for business investment, fell 1.8% over September, though are still up year-to-date 11%.
- Initial jobless claims rose 2,000 to 393,000 in the week ended November 19, higher than the 375,000 mark, which indicates a recovering jobs market. Continuing claims rose to 3.691 million in the week ended Nov. 12 from 3.623 million the prior week.
- Thomson Reuters/University of Michigan’s U.S. consumer sentiment index rose to 64.1 in the final November reading from the 60.9 in October.
- Oil prices fell to $96/barrel on Wednesday afternoon morning from $99/barrel the previous week.
The Real Economy
U.S. third-quarter GDP was downwardly revised to a 2.0% rate of annualized growth from an earlier estimated 2.5%. The reading was weaker than the 2.5% rate expected by consensus, though better than the 0.7% average rate for the first half of the year. The bulk of the revision came from inventory reduction, though personal consumption expenditures, equipment spending, government spending, and construction were also revised down. Only net exports were upwardly revised.
The larger contraction in inventories explains most of the overall downward revision in the report. Inventories now subtract $47.6 billion rather than the earlier estimated $33.7 billion. The revisions take 1.6% off the GDP growth, rather than 1.08% in the advanced report. If the inventory component were flat, GDP would have been 3.6%.
The sharp contraction can be read two ways. Lean inventories can be considered good news for fourth-quarter growth prospects, as businesses need to stock up shelves to be ready for holiday sales. However, the reluctance to hold inventories also indicates that businesses remain concerned that product won’t sell, so they are holding back on stockpiling the products.
Consumer spending rose 2.3% in the second quarter, slightly downwardly revised from the 2.4% rate previously estimated, and higher than the 1.3% rate in the second quarter. Real government purchases were down 0.1% (versus a previous estimated flat reading). The decline is largely due to the 1.4% drop (versus a 1.3% previously expected decline) in state and local spending as politicians continue to clean up their books. Federal spending was also revised down to a 1.9% gain (was up 2.0%). Private fixed investment was downwardly revised slightly, and across all sectors, but to a high 12.3% rate in the third quarter (versus 13.7%), to still offset the weakness in the government. Net exports added an upwardly revised $15.7 billion to third-quarter growth (was estimated at $7.0 billion), to contribute 49 basis points (bps) to GDP growth.
October orders for durable manufactured goods fell 0.7% over the September rate, not as bad as the 1.0% decline expected by consensus and our expected 1.3% drop. However, it comes after the prior month was sharply downwardly revised to 1.5% decline (previously down 0.6%). The drop was largely from a 16.4% drop in aircraft orders due to a pullback in Boeing orders after a 26.8% decline in September. Auto orders actually jumped 6.2% on continued improvement in supply deliveries following the Japan earthquake disruptions. Excluding transportation, orders were largely as expected, reporting a 0.7% October rise from a downwardly-revised September figure. Core capital goods orders--excluding defense and aircraft, a key leading indicator for business investment--fell 1.8% over September. They are still up 11.0% year-to-date. Core shipments were down 1.1%, though are up 9.6% year-to-date. Inventories rose 0.5%, and are up 11.7%, year-to-date. The strength of the current expansion depends more on the rebound for businesses than consumer spending, as we need sustained strong investment growth to see the usual sharp bounce in income and sales that generally follows deep recessions. The slowdown in core shipments and orders, if it holds through the year, implies softer capital spending in the fourth quarter than the 7.9% we currently expect.
A Home For The Holidays
Surpassing expectations, October existing home sales rose 1.4% over the previous month to an annualized 4.96 million units, after sales in September fell to 4.9 million. Sales are up 13.5% from the 4.38 million units in October 2010. As the Realtors Association reported, existing home sales have remained close to the current level for most months of this year. Despite favorable affordability conditions, rising rents and that “more creditworthy borrowers are trying to purchase homes,” contract failures have quadrupled over last year as banks tighten lending requirements and appraisals. Lower limits on loans for conventional mortgages are also hindering sales by forcing even the most creditworthy borrowers to pay high interest rates. In October, only the Northeast reported a decline--of 5.1%--over September. Other regions saw double-digit, year-over-year sales gains. Condo/co-op sales remained flat at a seasonally adjusted 590,000 unit rate, while single-family home sales rose 1.6% to 4.38 million units. The median home price fell to $162,500 in October from $165,800 the month before, and is down 4.7% over last year. The inventory of unsold homes edged down to 8.0 months from 8.3 months in September. It is still well above the 5.5- to 6-month average in normal market conditions and doesn’t take into account the shadow inventory of distressed homes that have yet to enter the market, which adds a few more years of excess supply to the market. This demand and supply imbalance will likely add downward pressure on home prices and keep the housing recovery weak.
In addition to signing the dotted line on their new homes, consumers also kept on spending, and their moods lifted this month. October consumer spending slowed down and posted a rise of only 0.1% over September. Disposable income rose 0.3%, while the saving rate rose to 3.5% from 3.3% in September. The PCE price index fell 0.1%, while the core rate, excluding food and fuel, rose 0.1% in October. A bigger boost was seen in the University of Michigan’s consumer sentiment index which rose 3.2 points to 64.1 in the final November reading. Current conditions climbed to 77.6 from 75.1 in October. The economic outlook index climbed to a four-month high of 55.4 in November from 51.8 the previous month. Inflation expectations one year ahead remained at 3.2%, the same rate as in October.
Thanks For Nothing
On the eve of Thanksgiving, amid the mixed and subpar U.S. economic data on hand, along with warnings of a much worse outlook for the eurozone, we thought that the 12-member Super Committee would have been motivated to definitely agree on some sort of partial plan before the deadline this week. We were wrong. The Super Committee failed to come up with any plan, passing the ball on to Congress to tackle the deficit before painful automatic budget cuts kick in 2013. While politicians on both sides of the aisle are devising ways to circumvent the spending cuts, President Obama, Speaker Boehner, and House Democratic Leader Pelosi have signaled their intention to stick to the original deal. While our baseline forecast factors in an extension of the 2% payroll tax holiday or long-term unemployment benefits, the failure to reach a deal increases the risk that no compromise will be reached to extend these benefits, which will be forced to expire at year’s end.
The Federal Reserve said on Tuesday that it would be requiring the largest U.S. banks with $50 billion or more in assets to stress test their books against a deep recession, with the unemployment rate of 12% in 2012 and 13% in 2013 and GDP falling 8%, peak to trough. How these institutions perform on these tests will factor into if and how much they can extend share buybacks and dividends. The move is likely an effort to reduce worries on whether U.S. banks can withstand the risk of the eurozone crisis spreading on our shores. Let’s hope it works.
Financial Market Highlights
Treasury yield curve
The 10-year Treasury yield dropped to 1.94% on Wednesday (early afternoon) from 2.01% last week, on speculation that the spreading European debt crisis is slowing global growth while the apparent failure of the U.S. deficit reduction Super Committee continued to bolster demand for U.S. treasuries. The rate on three-month Treasury bills gained 1 basis point (bp) this week to 2 bps. The two- to 10-year spread dropped 8 bps to 171 bps over the week and was 64 bps lower than a year ago. The 10-year Treasury spread above inflation-protected bonds, a measure of inflation expectations, dropped 11 bps over the past week to 141 bps and was 3 bps above the previous year.
Credit markets
Risk aversion remained in all market segments this week as worries rose that the eurozone debt crisis is spreading to core eurozone countries. The equity market volatility index (VIX), a measure of the market’s uncertainty, dropped to 31.97 from 34 the previous week. The T-bill-to-eurodollar (TED) spread, a measure of banks’ willingness to lend, increased 2 bps to 47 bps this week and was up 33 bps from a year ago. Fixed mortgage rates remained unchanged this week at 4%, keeping borrowing costs near the lowest on record, as investors sought the safety of government bonds amid turmoil in the eurozone. Mortgage applications fell 1.2% during the week ended November 18, after a 10% rise the prior week. The refinance index dropped 4%, after falling 12.1% the prior week. The purchase index rose 8.2% this week, after dropping 2.3% the prior week.
Fed policy and interest rate outlook
The FOMC maintained the federal funds rate at a record low of 0%-0.25% at its Nov. 1-2 meeting, and did not make any changes in its monetary policy stance. It will continue to reinvest principal payments into mortgage-backed securities, though it decided not to move into another round of quantitative easing at this time. While the Fed kept in place the "significant downside risks" phrase, the Fed's outlook was slightly more upbeat, stating that third quarter economic growth "strengthened somewhat," on a reversal of "temporary factors." The surprise in the statement was the one dissent on the dovish side of the board from Chicago Fed President, Charles Evans, who "supported additional policy accommodation at this time." Earlier, the Fed released its new economic projections, which were weaker than the June forecasts. The Fed cut the "central tendency" projection of 2011 GDP growth to 1.6%-1.7% from 2.5%-2.9%, with the core consumer deflator forecast up 1.8%-1.9% (from 1.5%-1.8%). The Fed lowered its jobs forecast and expects unemployment to fall to around 8.6% in late 2012, to around 8% in 2013, and between 6.8% and 7.7% at the end of 2014. Minutes to the FOMC September 20-21 policy meeting showed that policymakers were split on what type of accommodative monetary tools the central bank should use to try and kick-start the economy. While there were a number of opinions on the inflation outlook, most judged that inflation risks were roughly balanced with little risk of deflation. The Fed decided to extend the maturities on its balance sheet (Operation Twist), though two officials wanted to do more and some wanted to hold open the option for QE3. However, the members generally anticipated a pick up in the pace of the recovery although they saw "significant" risks to growth, with the recovery more vulnerable to shocks. The Beige Book compendium of reports from the 12 Federal Reserve district banks (released October 19) indicated that stronger economic activity than in the last survey, with most districts reporting economic growth as “modest” or “slight.” The report showed an increase in manufacturing activity, and gains in consumer spending coming largely from car sales and tourism. Several regions noted that an uncertain economic outlook is keeping businesses cautious and holding back business spending.
Global interest rates
Government long-term bond yields were largely up this week. Key central banks remain cautious in their outlook. Recent trends include:
- The ECB reduced its benchmark refinancing rate to 1.25% on Nov. 3. New ECB president Mario Draghi said that growth in the eurozone was likely to remain weak and the region was headed for a “mild recession” by next year. He added that Europe’s financial crisis and a slowdown in global growth meant that the eurozone faced an “environment of high uncertainty.”
- The Bank of England held its bank rate at 0.5% at its November 10 meeting as policymakers gauged the capacity of their 275 billion pounds ($438 billion) stimulus to ward off the dangers posed by the eurozone’s debt crisis.
- The Bank of Japan left its ultra-loose monetary policy steady at a range of 0.0%-0.1% in its Nov. 15 monetary policy meeting. It cut its economic assessment as the economy faces adverse effects from the slowdown in the global economy, the appreciation of the yen and flooding in Thailand.
- The U.S. Federal Reserve left the federal funds rate at 0%-0.25% at its Sept. 21 meeting. The Fed stated that it will sell $400 billion worth of shorter-term Treasuries it holds and reinvest in Treasuries maturing between six and 30 years by the end of June 2012, confirming that it would implement “Operation Twist” in its FOMC statement.
- The People’s Bank of China raised its benchmark interest rate by 25 bps to 3.5% on July 6, its third rate hike this year, in order to rein in high inflation. The move comes despite recent fears of an economic slowdown in the country, indicating that taming inflationary pressures remains a top priority for the Bank.
- The Bank of Canada held its target overnight rate at 1% on Oct. 26, amid weak economic growth and lower inflation forecasts.
- The Norges Bank held the deposit rate steady at 2.25% during its meeting on Sept. 21.
- Sweden’s Riksbank maintained its seven-day repo rate at 2% on Oct. 27, indicating that it would reduce its tightening outlook on signs of a slowing economy and rising uncertainty as European leaders struggle to contain the debt crisis.
- The Swiss National Bank cut its interest rate target band to 0.00%-0.25% from 0.00%-0.75% to stem the rise of the Swiss franc.
- Poland’s central bank left its seven-day reference rate at 4.50% on Nov. 9 on heightened uncertainty about global economic developments, as it continues to monitor what impact the eurozone debt crisis will have on the Polish economy.
- The Reserve Bank of Australia cut its benchmark interest rate for the first time in 2.5 years by 25 bps to 4.5% as inflation risks fade, unemployment rises and the global economic outlook continues to worsen.
- The Reserve Bank of New Zealand left its key rate unchanged at 2.5% on Oct. 26 given the rising uncertainty on the European debt crisis as well as slow global economic growth that threatens the nation’s recovery from the February earthquake.
- South Korea’s central bank left its key interest rate unchanged at 3.25% in its Nov. 11 monetary policy meeting for a fifth straight month, rejecting any increase amid fresh fears over Europe’s debt crisis and easing inflation.
- The Bank of Thailand left its benchmark overnight rate unchanged at 3.50% on Oct. 19, halting a seven-month streak of monetary tightening, as it assesses the nation’s mounting economic losses caused by the worst floods in five decades.
Foreign exchange rates
The dollar remained strong this week until Tuesday against other major currencies on worries about Europe’s debt problems, and the inability of U.S. lawmakers to agree on a deficit cutting plan left investors shifting into safe haven assets like the U.S. dollar. The euro dropped to $1.333 on early Wednesday afternoon from Friday’s $1.351 as investors shunned eurozone assets on concerns over the stability of the region’s banks and signs that the debt crisis is starting to threaten even Germany. The yen fell to ¥77.57 per dollar on Wednesday (early afternoon) from ¥76.89 per dollar on Friday. The U.S. trade deficit narrowed unexpectedly in September to its lowest level this year to $43.1 billion from a revised $44.9 billion in August. Exports surged 1.4% to $180.4 billion in September, boosted by overseas shipments of industrial supplies, capital equipment, and autos. Imports rose a meager 0.3% to $223.5 billion, burdened by a decline in imports of consumer goods.
Commodity price indices
Commodity prices rose this week as investors rushed to the safe haven assets as debt woes increased in the U.S. and Europe. Oil prices fell sharply to $96.01/barrel on Wednesday (early afternoon) from the prior week’s $99.02/barrel, dented by weak economic data in China and the U.S., while eurozone debt worries and sluggish growth kept investors wary of holding demand-sensitive commodities. Brent crude oil prices rose to $107.69/barrel from $109.45/barrel the previous week and continue to remain high relative to West Texas Intermediate (WTI). Natural gas prices dropped slightly to $2.50/mbtu this week from $2.52/mbtu in the previous week. Gold prices fell to $1,682/ounce on Wednesday (early afternoon) from $1,728/ounce a week earlier, as investor anxiety deepened over the European debt crisis, prompting the resulting rise in the U.S. dollar to mitigate the impact of safe-haven bullion buying. Livestock prices remained stable this week and are up 6.2% over the past year.
U.S. equity market
U.S. equity markets weakened further this week to their lowest level in a month, as fears that the eurozone debt crisis is spreading and a downward revision of U.S. third quarter GDP weighed on investor sentiment. The S&P 500, Dow, and Nasdaq were down and trading at 1,168, 11, 327, and 2,474, respectively, on Wednesday (early afternoon). Stocks were in a bear market from October 2007 until March 2009. Despite recent losses, they have now recovered much of those losses. All market indices remain up during the past year. The S&P 500 is now down 7.1% from the end of 2010 level of 1,258 and is up 72.7% from its March 9, 2009 low of 676.
U.S. equity market by sector
Equity sectors remained under pressure over the past week through Tuesday. Uncertainty about the progress of the eurozone bailout plan continues to hang over the financial sector, which plunged 4.9%, followed by material stocks, which were down 4.5%. Utilities and energy shares saw the largest 12-month gains (up 10.3% and 8.2%, respectively). Financial stocks, burdened by Europe’s debt crisis, posted the largest 12-month decline (down 15.7%).
Global Standard & Poor’s stock indices
World equity markets hit their lowest level in six weeks this week through Tuesday, as investors fretted as the cost of insuring European government debt against default rose to a record on concerns that the region’s crisis is worsening. Asia-Pacific markets led the decliners (down 5.5%), followed by Latin American markets (down 4.1%). All the major global equity markets have now turned negative for the 12-month period led by Japanese markets (down 20.1%), except U.S. markets, which were up 1.6%.
Global equity market performance by sector
International sectors dropped this week through Tuesday. Material stocks dropped the most (down 7.5%), followed by the financial sector (down 7%). During the past year, consumer staples stocks posted the largest gains (up 4.4%), followed by health care stocks (up 3.1%). In contrast, financial stocks dropped the most during the past year (down 21.4%), followed by material stocks (down 15.6%).
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