Economic Week in Review

ECRI Weekly Leading Index 135.50 +1.19%

The ISM Non-manufacturing Index for March, which accounts for about 85% of the U.S. economy, rose to an all-time record high of 65.8 vs. 60.8 in February and expectations of 61.5. "This is a very strong report -- its confirmation of the big rise in payrolls we saw Friday, and it's a sign that consumers are spending," said Chris Low, chief economist at FTN Financial. Allen Questrom, CEO of J.C. Penney, said that the tax cuts have been a key issue in the last couple of years in terms of restarting the economy's growth engines and biding time for corporations to begin spending again. Penney plans to add more new stores than it has in the past several years, Questrom said. 15 of 17 industries reported increases in business, led by wholesalers, mining, communications, retail and construction. The index of prices paid, a measure of costs for purchased materials and services, surged to 65.7 from 57.3 in February. The survey's employment index rose to 53.9, the sixth straight month of growth. Furthermore, CEO's may be gaining optimism and showing that in their hiring plans, a quarterly survey showed. The NY-based Conference Board's index of business confidence rose to 73 in the first quarter, the highest reading since 1983.

Morgan Stanley and Lehman Brothers said they will cut their U.S. budget deficit forecasts by $40-50B for 04 as strong economic growth, smaller-than-expected tax refunds and slower government spending all contribute to a smaller deficit.

Executives at Starbucks, McDonalds, Microsoft, Coke, Nike, Ford, GE and American Airlines all said they aren't seeing any negative impact on their businesses overseas, notwithstanding the recent geopolitical turmoil. A Harris Interactive poll conducted Feb. 27 to March 4 in Britain, France, Germany, Spain and Italy found that only 13% of those surveyed had a negative opinion of Americans.

Higher energy prices don't threaten growth in the U.S. economy or add much to inflation concerns, William Poole, president of the Federal Reserve Bank of St. Louis told USA Today. "There is no regular and reliable relationship between inflation in materials prices or goods at an early stage of production and retail price inflation," Poole said. Unit Labor Costs, which account for 70% of inflation have been falling since the early 80's. "As long as there are no threats to the continuation of low and stable inflation, then we have space, to be slower in raising rates than we would if we start to see conditions developing that do show threats to the inflation environment," Poole said.

The National Association of Realtors, raised its estimate for home sales for the fourth time this year, saying stronger jobs growth will offset a rise in interest rates. The Association also expects the average price of a home to rise another 4.5% this year after last year's 7.5% rise.

The Import Price Index rose .9% in March vs. a .4% rise in February and expectations of a .6% rise. Excluding petroleum, import prices have climbed 1% in 12 months, the smallest rise since a similar gain in October. The increase in consumer prices excluding food and energy has remained tame, rising 1.2% over the 12 months through February, close to the smallest gain since 1966.

Initial Jobless claims for the week ending April 3 were 328K vs. 342K the prior week and expectations of 340K. Increasing demand from the strongest economic growth since the early 80's is making it harder for companies to rely on productivity gains from existing workers. Moreover, corporate profits last quarter reached an all-time record high of 8.5% of GDP, thus giving companies the financial ability to increase hiring. A recent survey by the Conference Board showed that over half of all CEO's surveyed planned to increase hiring in the near future. "Companies are hiring and starting to rebuild inventories and that is a sign of confidence," said James O'Sullivan, a senior Economist at UBS Securities. Finally, optimism among U.S. manufacturing executives in March reached an all-time record, Manufacturers Alliance/MAPI said.

Worldwide sales of semiconductor manufacturing equipment rose 10% last year and will surge 40% in 2004 as chipmakers upgrade plants and buy tools for new production techniques, researcher Gartner said. The International Monetary Fund expects the U.S. economy will expand 4.6% this year, the most since the early 80's. The IMF cut its forecast for the 12 countries in the European Union to 1.7% for 04.

BOTTOM LINE: There are several key takeaways for the week. The U.S. service sector, accounting for 85% of the U.S. economy, is on fire. Corporate CEO's confidence is improving dramatically, leading to a rapid improvement in the employment picture. The Fed will likely raise rates at a slower pace than investors currently expect. The first hike will likely come in the next few months, however the magnitude and frequency of the increases will remain subdued until unit labor costs begin to rise substantially. Considering the extent that developing countries are effectively exporting substantial labor cost deflation, it is unlikely U.S. unit labor costs will rise materially in the near future.

The violence in Iraq over the past week will likely result in a modest decline in consumer confidence in the near future. However, I believe the situation is not nearly as bad as it appears. Without going into too much detail, I believe that the spurt of violence was a calculated political move orchestrated by the grand ayatollah of the Iraqi Shia, Ali al-Sistani. He is essentially using al-Sadr as a pawn to "remind" the U.S. that it needs to cater to his demands for the transition on June 30. al-Sistani has the power to put down al-Sadr at any time of his choosing. I believe the U.S. will work out a deal that is acceptable to al-Sistani, thus ending al-Sadr's brief moment of glory. If I am right, the violence has peaked or will peak in the near future. It is highly unlikely that al-Sistani and the U.S. commanders will allow the situation to spiral out of control.