Economic Notes – 9-17-12

September
17

Written by: Jon McGraw

Last week saw many important economic developments that – for most investors – made for a very good week.

Positives

Probably last week’s biggest news came out of Europe. Germany’s Constitutional Court ratified the country’s participation in the 700-billion-euro European Stability Mechanism (ESM), the euro zone bailout fund. Germany is liable to contribute 27% of the ESM, or about 190 billion euro. Combined with the European Central Bank’s plans to buy the government bonds of struggling countries and the establishment of the ESM, investors will see the European crisis in better control, which is certainly positive to global capital markets.

As the market expected and longed for, the Federal Open Market Committee announced the third round of quantitative easing (“QE3”) to help foster maximum employment. The Fed will purchase additional agency mortgage-backed securities at a pace of $40 billion per month. In addition to June’s accommodative program, the Fed will acquire longer-term securities by about $85 billion each month, which would help keep longer-term interest rates from rising and help support the mortgage market. The committee also decided to extend current fed fund rates near the zero level from late 2014 to at least mid 2015.

The University of Michigan’s consumer sentiment index climbed to 79.2 in August from 74.3 in July, above the projected level of 74. Gradual improved consumer sentiment will help the economy to keep edging forward and support 70% of the economy.

Negatives

Initial jobless claims in the week ending September 8th rose unexpectedly to 382,000, an increase of 15,000 from the previous week. Special factors such as Tropical Storm Issac were cited to explain the approximately 9,000-application increase for initial unemployment benefits in several states. On the other hand, continuing jobless claims during the week ending September 1 declined by 49,000 to 3,283,000 from the preceding week.

Industrial production fell 1.2% in August, worse than the expected flat trend. Following a 0.5% gain in July, the index’s unexpected monthly decline in August is the largest since March 2009, highlighting risks to the economic outlook. Output from manufacturing, mining and utilities all went downward. Hurricane Isaac had a negative impact on industrial activities in the Gulf Coast region at the end of the month. It was estimated to have taken away 0.3% from the monthly rate of change in total industrial production.

Capacity utilization rates shrank by 1% from 79.2% in July to 78.2% in August, 2.1% below its long-run average of 80.3%. There is still quite a bit of slack in the economy to keep inflation in check.

Mixed

Headline CPI rose 0.6% in August, which was in line with expectations. However, it was the biggest monthly increase in CPI since June 2009. Gasoline saw the steepest price hike with a 9% increase from July, contributing 80% of August’s CPI increase. Over the past 12 months, the gasoline index has increased 1.8% while the total energy index has actually declined 0.6%. The food index rose only 0.2% in the month; however, higher food prices are likely to surface after the worst Midwest drought in 76 years. General price declines occurred for used cars and trucks, apparel, household furnishings and airline fares. Excluding food and energy, the core index increased 0.1% month-over-month and was up 1.9% year-over-year. Overall, inflation pressures remained contained.

The Producer Price Index (PPI) for finished goods increased 1.7% in August, higher than consensus expectations of 1.2%. The finished energy goods index jumped 6.4% and led to more than 80% of the broad-based rise in PPI. Excluding foods and energy, the core PPI advanced mostly by 0.2%, which was in line with expectations.

Retail sales were up 0.9% month-over-month in August, slightly higher than the median forecast of 0.8%. Gasoline stations’ sales soared by 5.5% compared to July and were mainly driven by higher gas prices at the pumps. Building-material and garden-equipment stores and auto-and motor-parts stores all experienced above 1% increase in sales. Excluding the above items, the core component of retail sales rose only 0.1%, missing the 0.4% median forecast. Sales at electronics stores declined by 1.4%, the weakest in all categories.

Risky assets saw the most rallies last week after the positive ruling by the German high court and additional easing measures announced by the Fed. Foreign stocks outperformed domestic stocks for the week, helped by the weakening dollar and investors’ increased appetite for risk. Small-cap stocks beat large-cap stocks. From the sector perspective, energy, materials, and financial stocks led the market, while utilities, consumer staples and health care lagged. The release of the iPhone 5 sent Apple’s stock price to almost $700 per share. As the largest U.S. company ever, Apple’s market cap reached $648 billion.

The U.S. Treasuries yield curve steepened sharply, with the longer-term securities yield up the most. Bonds underperformed stocks. Investors shied away from treasuries and pursued mortgage-backed securities, corporate bonds and high yield bonds. Treasury Inflation-Protected Securities (TIPS) performed well, too, as investors raised their future inflation expectation.

The Fed’s further quantitative easing also sparked rallies in several commodity markets. For example, gold and silver have climbed to six-month highs as demand for a hedge against potential inflation rose. Geopolitical tensions in the crude-rich Middle East and the Fed’s accommodative stance to stimulate the economy strengthened global oil prices.