Economy Stutters Amid Worsening Credit Market Conditions

(RTTNews) - Even as the economy is showing significant weakness, a breakthrough was achieved this week in the crusade for stemming the rot in the troubled financial sector. The government has done its part by ensuring that the House as well as the Senate passed the modified 'Troubled Asset Relief Program'. Although there may be some improvement in the prices of mortgage-backed securities in the secondary market, credit market conditions are unlikely to recover before late 2008 or early 2009. According to Global Insight, the improvement in the mortgage securities market along with an anticipated 50-basis point reduction in fed funds rates before the end of October should bring some relief to the roiled banking system.

Wachovia Securities believes that the financial rescue package will not immediately reverse the troubles, but it will prevent them from becoming even worse. Consumers as well as businesses are facing financing difficulties.

Non-farm employment fell by a worse-than-expected 159,000 in September compared to the average decline of 75,000 for the period between January and August. More frightening is the prospect that October could see job losses of similar magnitude, given the credit crunch and the lagged effect of hurricanes. Total hours worked fell 0.5%. The weak jobs data has prompted many economists call for a fed funds target rate reduction to as low as 1%.

The Institute for Supply Management's manufacturing index declined sharply to 43.5 in September from 49.9 in the previous month, marking the biggest monthly decline since 1984. The new orders index fell by about 10 points to 38.8, while the production index also plummeted to 40.8. However, BMO Capital Markets noted that the weakness may have been overstated due to the Boeing strike and the impact of the hurricanes, as the regional surveys did not point to a slowdown anywhere close to the national survey.

Meanwhile, the services sector survey showed that activity expanded at a slower rate than in the previous month. The business activity index held steady at 52.1, while the new orders index rose slightly to 50.8. However, the employment index fell to 44.2 and the inventories index also suggested contraction. The NAPM-Chicago purchasing managers' survey showed that the region's business barometer edged down 1.2 points in September, although it remained above the '50' level at 56.7.

Factory goods orders declined by 4% month-over-month in August, a faster rate of decline than the 3% drop expected by economists. Orders and shipments of the core capital goods, which are the non-defense capital goods excluding aircrafts, were revised downwards to show 2.4% and 2.1% declines, respectively.

Light commercial vehicle sales declined 1.2 millions to an annualized pace of 12.5 million in September. The bulk of the weakness was in domestically produced light trucks, the sales of which dipped over 600,000 units.

Another report showed that personal consumption expenditure remained unchanged, softer than the 0.2% growth expected by economists. However, personal income rose 0.5% in August compared to the 0.2% growth expected by economists. That said, personal disposable income, which excludes direct taxes, fell 0.9%.

All these are definitive evidence that a recession has already set in. State Street noted that recent economic evidence suggests that the slowdown it has been predicting for the second-half of 2008 and early 2009 may now be worse-than-initially anticipated.

However, there were some bright spots that were few and far between. The Commerce Department's construction spending report showed that construction spending was unchanged in August compared to expectations for a 0.5% decline. Residential construction spending, excluding improvements, which is used for calculating GDP, fell 4.1%, while private non-residential spending fell 0.8% following a 1.1% drop in July. On the other hand, public construction spending rose 0.8% in August, extending the 1.3% increase in July. Meanwhile, the Conference Board's consumer confidence index rose to 59.8 in September from 58.5 in August. The present situation index fell 6.2 points to 58.8, but the expectations index rose 6.4 points to 60.5.

The upcoming week's economic calendar is fairly light, with a very few economic reports of significance scheduled to be released during the week. Traders may closely watch the minutes of the September 16th FOMC meeting, the Commerce Department's trade balance report for August and the National Association of Realtors' pending home sales index.

Additionally, market participants could also sift through the Federal Reserve's consumer credit report for August, the Labor Department's import and export prices report for September, the Commerce Department's wholesale inventories report for August and the regularly scheduled weekly jobless claims and oil inventories reports.

The minutes are likely to be analyzed to find out the probability of either an inter-meeting cut or the likely monetary policy stance at the October 29th FOMC meeting. Although the policy statement of the meeting had a neutral bias, most Fed officials have of late toned down their rhetoric on inflation. However, the minutes are unlikely to reflect the developments over the past two weeks.

Economists expect the trade deficit to have declined significantly in August due to a pullback in oil prices and a reduction in the demand for oil in reaction to the economic slowdown. However, the trade deficit, excluding petroleum, is likely to have widened, given the slowdown in exports, especially those of motor vehicles and parts.

The pending home sales index is likely to show another month of decline, although the rate of decline in August is likely to be slower than that in July. Sales have picked up to some extent due to the availability of heavily discounted foreclosures that have hit the market.

Import prices are likely to have declined again in September, although at a slower rate than in August. In August, energy prices experienced sharp declines and the dollar was firmer against most other currencies.

Monday

Chicago Federal Reserve Bank President Charles Evans and Dallas Federal Reserve Bank President Richard Fisher are scheduled to make public appearances at 12 PM ET and 1:30 PM ET, respectively on Monday.

Tuesday

Minneapolis Federal Reserve President Gary Sterns is scheduled to speak on 'The Financial Shock' in Chicago at 11 AM ET on Tuesday. Federal Reserve Chairman Ben Bernanke is due to speak at an economics conference on 'Economic Outlook and Financial Markets' at 1:15 PM on the same day.

The Federal Reserve is scheduled to release the minutes of its September 16th meeting at 2 PM ET on Tuesday.

At its September meeting, the Fed opted to leave its target for the fed funds rate unchanged at 2%. The discount rate was also maintained at 2.25%. In the post-meeting policy statement, the Federal Open Market Committee highlighted the financial market risks by giving priority to its reference to the issue. The Fed said, "Strains in financial markets have increased significantly and labor markets have weakened further."

The Fed acknowledged that economic growth slowed due to softening household spending, a deviation from the August statement, where it said, "Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports." Along with tight credit conditions and the ongoing housing contraction, the Fed noted that slowing export growth would weigh on economic growth over the next few quarters. In August, the central bank had alluded to elevated energy prices as one of the risks to growth.

The Fed repeated its rhetoric on inflation, while it left out the sentence that said the Committee expects inflation to moderate later this year and next year.

The U.S. Federal Reserve is expected to release its monthly consumer credit report at 3 PM ET on Tuesday. Consumer credit for August is likely to show an increase of $5.5 billion.

Consumer credit increased at a seasonally adjusted annual rate of 2.1% or $4.5 billion in July to $2.59 trillion. Economists had expected an $8.5 billion increase in consumer credit for the month. The increase came about due to a $3.9 billion increase in revolving credit. Non-revolving credit rose by $0.6 billion.

Wednesday

Philadelphia Federal Reserve President Charles Plosser is scheduled to speak on 'Fed Policies' in New York at 7:45 AM ET on Wednesday.

Data on Pending Home Sales, which is a leading indicator of housing market activity released by the National Association of Realtors, is due out at 10 AM ET on Wednesday. A pending sale is one in which a contract was signed but not yet closed. Normally, it takes four to six weeks to close a contracted sale. The consensus expectations call for a 1% decline in the index for August.

The pending home sales index declined 3.2% on a monthly basis in July compared to a 5.8% increase in the previous month. Lehman Brothers believes that the leveling off in existing home sales is being driven by an increase in foreclosure sales. Additionally, the firm is of the view that lower prices have brought some bargain seekers into the market. Overall, Lehman is of the view that the housing market is still very much out of balance with a huge excess of homes on the market for sale.

The Energy Information Administration is also due to release its weekly oil inventory report at 10:30 AM ET on Wednesday.

Crude oil stockpiles rose by 4.3 million barrels in the week ended September 26th to 294.5 million barrels. Crude oil inventories are now in the lower half of the average range for this time of the year.

Gasoline inventories rose by 0.9 million, while distillate stocks fell by 2.3 million barrels. Refinery capacity utilization averaged 73.7% in the four-weeks ended September 26th compared to 77.8% in the previous week.

Thursday

The nine-member monetary policy committee of the Bank of England is due to hold a two-day meeting ending Thursday to determine the near-term direction of monetary policy. Any change in the policy is announced at 7 AM ET on the same day.

At its September meeting, the Bank of England kept its benchmark interest rate unchanged at 5%. The decision was in-line with expectations, as economists expected the central bank to pause to contain inflation despite the slowing growth.

A Labor Department report on the number of individuals claiming unemployment benefits during the week ended October 4th is scheduled to be released at 8:30 AM ET on Thursday.

Jobless claims rose 1,000 to 497,000 in the week ended September 27th from the previous week's revised figure of 493,000. The increase came as a surprise to economists, who had been expecting jobless claims to edge down to 475,000 from the originally reported reading of 493,000.

The Labor Department also said that the less volatile four-week moving average rose to 474,000 from the previous week's revised average of 462,500. At the same time, the report showed that continuing claims in the week ended September 20th increased to 3.4591 million from the preceding week's revised level of 3.543 million.

The Commerce Department is due to release its wholesale inventories report at 10 AM ET on the same day. Economists expect wholesale inventories at the end of August to show 0.4% growth.

Wholesale inventories rose by 1.4% month-over-month in July, with the bigger-than-expected increase reflecting a pick up in inventories of durable goods, especially motor vehicle. Based on the report, Lehman raised its third quarter GDP estimate to 2.3% from the 2.1% quarterly rate it was estimating previously. However, wholesale sales fell 0.3% from the previous month. Year-over-year, wholesale sales and inventories are up 16.5% and 10.6%, respectively. The July inventories to sales ratio was 1.07 compared to 1.13 in the year-ago period.

Friday

The export & import price indexes for September, which gives the changes in the prices of non-military goods and services traded between the U.S. and the rest of the world, are due out at 8:30 AM ET on Friday.

Import prices declined at a monthly rate of 3.7% in August compared to a downwardly revised 0.2% growth in July. The negative growth reflects a 12.8% decline in the prices of petroleum imports and a 0.3% slippage in non-petroleum import prices. Annually, import prices jumped 16%, primarily due to a 52% surge in petroleum import prices.

Export prices fell at a 1.7% in August, reversing the 1.5% gain in the previous month. Agricultural export prices fell 9.6% compared to a 0.7% drop in export prices of non-agricultural commodities. On a year-over-year basis, export prices climbed 8.2%.

The trade gap data for August is due out at 8:30 AM ET on Friday. Economists estimate that trade gap narrowed to $60 billion in the month. The trade gap measures the difference between imports and exports of both tangible goods and services.

The July trade deficit widened to $62.2 billion from an upwardly revised deficit of $58.8 billion for June, which was originally reported as $56.8 billion. Exports increased $5.4 billion to $168.1 billion compared to an $8.7 billion increase in imports to $230.3 billion. Overall, the deficit on trade in goods rose $3.6 billion to $74.9 billion, while the services surplus increased $0.2 billion at $12.7 billion.

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