Saturday, April 24, 2004

Economic Week in Review

ECRI Weekly Leading Index 134.60 +.30%

The Index of Leading Economic Indicators rose .3% in March, meeting expectations and up from an unchanged reading last month. This was the largest year-over-year gain since 1984 and shows the U.S. economy is gaining momentum. Companies taking longer to fill orders on increasing demand, falling jobless claims, rising building permits and tax refunds putting more money in the hands of consumers, all contributed to the rise, Bloomberg reported. Taxpayers received $142.5 billion in refunds through April 2, compared with $131.4 billion at the same time last year. Finally, the increase suggests that economists may need to reconsider their projections of 4.3% growth for the second quarter.

The Producer Price Index for March rose .5% versus expectations of a .4% rise and a .1% increase in February. The PPI Ex Food and Energy rose .2% versus expectations of a .1% increase and a .1% gain the prior month. Exceptional economic growth in the U.S. and China is increasing demand for commodities, thus leading to price increases. "These are not alarming increases, but they are higher than they have been in a few years," said Christopher Low, chief economist at FTN Financial.

U.S. Federal Reserve Chairman Alan Greenspan said most U.S. banks are well positioned to adjust their balance sheets to higher interest rates. "Many banks indicate that they now either are interest rate neutral or are positioned to benefit from rising rates," Greenspan said. Bank asset quality is improving as U.S. banks charged off .75% of total loans as non-performing assets in the final quarter of 03, the lowest rate since the stock market bubble burst in 2000, Bloomberg reported. Alan Greenspan also said, "The threat of deflation is no longer an issue for the U.S. and companies appear to have a greater ability to raise prices." Greenspan dismissed rising commodity prices as an inflation threat, saying that they're a small part of total costs for companies. Moreover, Greenspan said, "Inflation pressures are reasonably contained as labor productivity helps hold down prices because firms can produce more goods in an hour." Labor costs, which account for 70% of inflation, are still declining. Non-farm unit labor costs fell .4% in the 4th quarter after a 5.6% decline in the prior three months, Bloomberg reported. Greenspan proceeded to say, "The U.S. economy is in a vigorous expansion that has not produced broad-based inflation pressures." "A rapid pace of growth is leading companies to add to payrolls, and once signs of accelerating inflation appear, the central bank will raise interest rates," Greenspan told the Joint Economic Committee of Congress.

Initial Jobless Claims fell to 353K last week versus expectations of 340K and 362K the prior week. Continuing Claims rose to 3019K versus expectations of 2988K and 2967K the prior week. "Job creation is still going at a healthy clip, but not at a rate that's appreciably stronger than what we say in the first quarter," said Richard DeKaser, chief economist at National City. DeKaser expects 170,000 jobs were added in April, a month after the biggest gain in almost 4 years, Bloomberg reported.

Durable Good Orders for March rose 3.4% versus expectations of a .7% rise and a 3.8% rise in February. "The manufacturing sector is on fire," said Anthony Chan, chief economist at Banc One Investment Advisors. The jump in orders makes it more likely companies will boost work hours and hiring, Lehman Brothers economist Drew Matus said. The report also suggests business investment exceeded 10% for a third straight quarter, said Steven Wieting, an economist at Citigroup Global Markets. Kenneth Goldstein, chief economist of the Conference Board, said "We're seeing the beginning of a turnaround for the national labor market with the volume of help-wanted ads rising after 3 years of declines." Gannett Co., the biggest U.S. newspaper publisher, said last week its help-wanted ads soared 23% in March. Help-wanted ads are a tremendous indicator because companies don't advertise for employees unless they intend to hire in the next month or two. The fact that it's gotten a lot better in February and March suggests that the pace of economic activity is really improving, Bloomberg reported.

BOTTOM LINE: There are several key takeaways for the week. I now believe that the U.S. economy grew nearly 6% in the first quarter versus economist's estimates of 4.6% growth. I also think second quarter economic growth will be stronger than current expectations of 4.3%. While inflation is not currently a problem, the Fed is preparing the markets for a rate hike in the near future. Unit labor costs, which are 70% of inflation, remain subdued. As well, a stronger dollar and slowing Chinese economy are already contributing to lower commodity prices. The Fed Funds rate, however, is at emergency levels and these levels are unwarranted in the current economic environment. I continue to expect the first rate hike to occur at the June 29-30 meeting, while market expectations are for a raise at the August 10 meeting. Finally, while job creation will temporarily slow from last month's strong pace, the large increase in help-wanted ads and exceptionally strong durable goods report bodes well for another large jobs number in the near future.

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