July 2010 Personal Income and Outlays, Retail Sales and Consumer Debt: Spending Outpaces Incomes

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Bureau of Economic Analysis data revealed that personal consumption expenditures (PCE) outpaced disposable personal income (DPI) in July. DPI increased $17.6 billion (0.2 percent) while PCE rose by $44.1 billion (0.4 percent) relative to June. Year-over-year percentage gains in consumer spending have exceeded incomes during the most recent five months, although -- except in May -- the spread has not been very great.

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Retail-sale activity paralleled PCE in July, rising 0.4 percent compared to June -- the first increase in retail sales in five months. Most of the gain came from vehicle sales and higher gasoline prices; excluding those two sectors, retail sales were down 0.1 percent.

Although the personal saving rate declined to 5.9 percent in July (from 6.2 percent in June), consumers are perceived as remaining “very cautions.” For example, J.C. Penney and J. Crew have both lowered their annual earnings outlooks. "The continued economic uncertainty we're seeing is leading us to take a more conservative outlook for the second half of the year," Mickey Drexler, J. Crew’s CEO, said on a conference call.

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Despite the perception of caution, total consumer debt outstanding is in the process of leveling off after retreating since mid-2008. And in fact, non-revolving debt increased for a third month in July. So, while consumers may not be loading up debt on their credit cards, they are still “shelling out” for bigger-ticket items (e.g., the vehicles mentioned above).

August 2010 Currency Exchange Rates: U.S. Dollar Slips Again

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The U.S. dollar depreciated “across the board” in August: by 0.2 percent against Canada’s “loonie,” 0.7 percent against the euro and 2.4 percent against the yen. On a trade-weighted index basis, the dollar gave up 0.8 percent against a basket of 26 currencies.

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Canada: The loonie essentially moved sideways in August as the impact of a slight rise in oil’s price was nearly offset by the downward revision of 1Q2010 GDP (to 5.8 percent, from the 6.1 percent initially reported), and a weaker-than-expected 2.0 percent GDP rise during 2Q.

Europe: With no recent confidence-rattling “blow-ups,” the European banking and sovereign debt problems seem to have receded into the back of the markets’ collective conscience. Even Standard & Poor’s downgrade of Ireland’s sovereign debt was largely ignored. Attention appears to be concentrated instead on reports of the quickening pace of 2Q GDP growth in the 16-nation Euro Area, more optimistic economic sentiment, and rising exports.

Japan: The markets appear to have concluded that Japan’s fiscal problems will not come to a head in the near future, and thus bid up the yen’s value to levels not seen since 1995. Attempts by finance officials to “jawbone” the yen lower via threats of intervention came too late in August to make a difference. “Verbal interventions aren’t working any longer,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. “Upward pressure on the yen won’t go away.”

Nearly as ineffective (at least so far) was the emergency meeting held on August 29, during which the Bank of Japan (BOJ) decided to boost liquidity available to banks by another $119 billion. In fact, the yen appreciated against all 16 of its most-traded counterparts after the BOJ’s announcement. "If the Bank of Japan's policy [response is limited to] increasing its liquidity provisions, it's not enough to substantially weaken the yen," said Camilla Sutton, a Bank of Nova Scotia currency strategist in Toronto.

As analyst Mike “Mish” Shedlock recently observed, ”The sad state of affairs is every country wants a weak currency to fuel exports. The reality is it's mathematically impossible. The irony is how hard it is for Japan to destroy its currency, even when that is the clearly stated goal.”

August 2010 ISM Reports: Manufacturing Jogs; Services Crawl

The Institute for Supply Management’s (ISM) reports on the manufacturing and service sectors provide a more up-to-date view of conditions than either the Federal Reserve Board’s report on industrial production and capacity utilization or the U.S. Census Bureau’s report on manufacturers’ shipments, inventories and orders.

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With a 0.8 percentage point increase in its PMI, manufacturing expanded at a slightly faster pace in August. "Manufacturing activity continued at a very positive rate in August as the PMI rose slightly when compared to July,” said Norbert Ore, chair of ISM’s Manufacturing Business Survey Committee. “In terms of month-over-month improvement, the Production and Employment Indexes experienced the greatest gains, while new orders continued to grow but at a slightly slower rate. August represents the 13th consecutive month of growth in U.S. manufacturing."

Paper manufacturing lengthened its string of positive changes in August, but all characteristics of Wood Products performance remained unchanged for a second month.

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Growth in the service sector slowed to a crawl in August; the non-manufacturing index fell 2.8 percentage points (to 51.5 percent). Construction and Real Estate were among the top three industries reporting expansion; Agriculture, Forestry, Fishing & Hunting led the list of contracting industries. The employment index dropped to 48.2, which means service industries shed employees in August. "Companies are really holding back," Anthony Nieves, chair of the ISM services survey. "They've had this wait-and-see attitude for quite some time."

Survey respondent comments ranged from "Continuing to show signs of positive growth" in Construction to "Business is pretty stagnant; starting to see price erosion in our selling markets" in Ag & Forestry.

The services figure is "certainly not a disaster, but a reminder that we're in a fragile environment," said Paul Ashworth, senior U.S. economist at Capital Economics Ltd. in Toronto. "The recovery is just not strong enough. It's still being driven by manufacturing, with the rest of the economy lagging a bit behind."

Input prices rose at a moderate pace for manufacturing industries and jumped significantly for the service sector. Relevant commodities whose prices increased in August include: caustic soda, coated groundwood (also listed in short supply), diesel fuel and gasoline. No relevant cmmodities were down in price.

August 2010 Employment Report: The Private Sector Throws an Undersized Life Preserver

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The unemployment rate nudged higher in August for the first time in four months as weak hiring by private employers failed to keep pace with the decline in government workers and a large increase in the number of people looking for work. Firms added a net total 67,000 new jobs last month, down from July's upwardly revised total of 107,000 (originally 71,000); but with the departure of 114,000 Census workers, the economy lost 54,000 jobs -- the third consecutive monthly decline. The unemployment rate rose to 9.6 percent, after holding steady at 9.5 percent for three months, as discouraged workers came back into the labor force to hunt for jobs.

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As of August, the U.S. economy has lost 7.64 million (5.5 percent) of the jobs that existed at the peak of employment in December 2007.

The markets initially shrugged off the employment fallback, choosing instead to concentrate on the more positive news of private-sector job gains. "These are very nice numbers for the labor market," said Kathy Lien, a director of currency research at GFT in New York. "It means for the time being, some of the fears of weakness in the U.S. economy may be misplaced as the data shows the labor market is not as bad as feared."

Because the private sector continued hiring, "the double-dip talk was probably misplaced," said Maury Harris, chief economist at UBS Securities LLC in New York. However, "from a historical perspective, things are still soft. The economy ought to be doing better."

"There is less reason to be concerned about the trajectory of the economy in the very near term," concurred Louis Crandall, chief economist at Wrightson ICAP LLC in New Jersey, “but labor market trends remain weaker than the Fed is willing to tolerate in the long run. Continued stagnation will exhaust the Fed's patience at some point."

As we have indicated in the past, what the markets seem to be ignoring is that at least 100,000 jobs need to be created each month just to keep up with population growth. Since nonfarm employment bottomed out last December, job creation has averaged under 90,500 per month. Thus, the pace of hiring will have to increase dramatically to not only keep up with younge people entering the work force for the first time, but also to once again make those 7.64 million displaced workers productive.

August 2010 Monthly Average Crude Oil Price: Nearly Unchanged

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The monthly average U.S.-dollar price of West Texas Intermediate crude oil inched up by $0.45 (0.6 percent) in August, to $76.82 per barrel. That price increase coincided with a weaker dollar, the lagged impacts of a jump in consumption of nearly 0.5 million barrels per day (BPD) in June, and despite high (and rising) crude stocks.

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Recent oil-related developments include the following:

• Debate continues to rage about how much oil remains in the Gulf of Mexico in the wake of the BP PLC spill. Most of the oil that leaked from BP's Macondo well between April 20 and July 15 is still beneath the water's surface, five scientists including Samantha Joye, a professor of marine sciences at the University of Georgia in Athens, concluded in a mid-August memo. Charles Hopkinson, another of the five researchers, said plumes of oil dispersed underwater remain a threat. "One major misconception is that oil that has dissolved into water is gone and, therefore, harmless," Hopkins said. "The oil is still out there, and it will likely take years to completely degrade. We are still far from a complete understanding of what its impacts are." Other scientists believe most of the oil has dissipated. "I don't think it's still lurking out there," said Edward Overton, an environmental chemist and professor emeritus at Louisiana State University. "The Gulf is incredible in its resiliency and ability to clean itself up. I think we are going to be flabbergasted by the little amount of damage that has been caused by this spill."
  
  
• The federal judge who overturned the Obama administration's initial six-month moratorium on deepwater oil drilling has rejected the government's bid to have the court challenge thrown out. Government lawyers argued that a lawsuit filed by several offshore service companies over the May 28 moratorium was moot because the Interior Department imposed a new, temporary drilling ban on July 12. But U.S. District Judge Martin Feldman rejected that argument on September 1, saying the second moratorium "arguably fashions no substantial changes" from the first that had been imposed following the massive BP PLC oil spill.
  
  
• In what seems like deja vu, another offshore oil rig has exploded in the Gulf of Mexico, The blast, which was reported mid-morning on September 2, was located about 80 miles south of Vermilion Bay along the central Louisiana coast, and west of the site of the April blast that caused the massive oil spill. Initial reports indicated all 13 crew members from the rig were in the water; one was injured, but there were no deaths. The platform, owned by Mariner Energy, was not extracting crude prior to the fire.
  

July 2010 Manufacturers’ Shipments, Inventories and New Orders: Anemic Growth

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Shipments, inventories and new orders at the total manufacturing level all posted modest gains in July, according to the U.S. Census Bureau.

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Shipments, up following two consecutive monthly decreases, increased $4.4 billion (1.1 percent) to $417.1 billion. Durable goods, up four of the last five months, increased $4.5 billion (2.3 percent) to $200.6 billion; transportation equipment had the largest increase -- $3.4 billion (7.0 percent) -- within durable goods. Nondurable goods declined for a fourth month (by $0.1 billion in July).

Shipments from solid wood manufacturers declined by 0.5 percent while paper manufacturers saw a 1.9 percent increase.

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Interestingly, data from the Association of American Railroads indicate an overall decrease in the volume of rail traffic in July; this decrease extended into forest products-related shipments. Based upon results of the Ceridian-UCLA Pulse of Commerce Index for July, however, some of the slack in rail traffic may have been absorbed by the trucking industry.

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Total inventories inched up in July, by $5.1 billion (1.0 percent). The inventories-to-shipments ratio was unchanged at 1.26. The $1.7 billion (0.6 percent) advance in durable goods was led by machinery. Petroleum and coal products led the increase in inventories of nondurable goods.

Solid wood inventories fell by 1.3 percent while paper rose 0.6 percent.

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The markets had mixed reactions to the report on new orders, primarily because overall growth was anemic and activity was concentrated in the aircraft sector. Overall, new orders rose $0.6 billion (0.1 percent). Excluding transportation, new orders decreased 1.5 percent -- the biggest drop in 16 months. Durable goods orders increased $0.7 billion (0.4 percent) while orders for nondurable goods were essentially unchanged at $216.5 billion.

"This report is consistent with the loss of momentum we're seeing in a lot of reports," said James O'Sullivan, chief economist at MF Global, in reaction to the preliminary, late-August report (which was more encouraging than the final report). "The economy has clearly downshifted," he said, noting that the debate is now centered on how long the soft-patch will last.

July 2010 U.S. Construction: Building on Sinking Sands?

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Overall construction spending tumbled in July to the lowest level in a decade. The value of construction put in place dropped 1 percent in July, the third straight monthly decline; the fall-off was particularly noteworthy in light of revisions that showed activity during May and June was much weaker than previously reported. Private non-residential construction was the only subset of activity to post a gain in July.

"Housing is fairly weak and construction related to the stimulus is fading," Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit, said before the report was issued. "Some commercial projects may have been delayed as businesses are uncertain about the outlook."

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Although the value of private construction put in place declined in July, the number of total housing starts nudged higher (1.7 percent). Even so, starts remain near the lowest levels since the Census Bureau began collecting data in 1959; also, the drop-off in permits gives little reason to expect a turnaround.

"The tax credit brought forward some demand, and now we're in the middle of the payback," said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. "We're in a deep hole right now. There's no sign that we're about to climb out of it."

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The 1.7 percent rise in total starts resulted from the jump in multi-family starts (28,000, or 32.6 percent) more than offsetting the drop in single-family starts (-19,000, or -4.2 percent). Despite the July uptick, total starts remain in negative territory on an annual percentage change basis.

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With new-home sales retreating to an all-time recorded low in July, the ratio of starts to sales remained elevated. Granted, this ratio is something of an apples-to-oranges comparison, since starts include all activity while sales include only "spec" houses (i.e., excluding homes built on contract). Nonetheless, it gives an indication of the balance (or lack of same) between supply and demand.

"The housing market's recovery has taken a big step back," said Ryan Sweet, a senior economist at Moody's Economy.com. "The improvement in the labor market is showing signs of fatigue and potential buyers are content to sit on the sidelines, which is understandable considering we have a near double-digit unemployment rate."

Mitchell Hochberg, principal at Madden Real Estate Ventures in New York, concurred with Sweet. "The [new-home sales] report shows the housing industry is still nursing a bad hangover," Hochberg wrote in an e-mail. "With shadow inventory, rising foreclosures, little job growth and more stringent access to credit, weak sales will persist and the industry's headache will linger."

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A comparison between completions and sales tells much the same story. Although completions were substantially lower in July than June, and the inventory of new homes was unchanged in absolute terms, the decline in sales pushed months of inventory back above nine months (at the July sales pace).

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July’s sales of previously owned homes were more disappointing, both in absolute and percentage terms. For comparison, new-home sales dropped by 39,000 units (SAAR), but -1.43 million for resales. The inventory of existing homes ballooned to 12.5 months at the July sales pace.

"This is a devastating reading on the U.S. housing market," said Derek Holt, an economist at Scotia Capital Inc. in Toronto. "There's such an inventory overhang, it shows there will be pressure on prices" in the months ahead.

One reason the market is hurting is that buyers and sellers are in a standoff over prices. Many sellers are reluctant to lower their prices. And buyers are hesitating because they think home prices are likely to move lower. "It really is a self-fulfilling prophecy," said Aaron Zapata, a real estate agent in Brea, CA. "If all buyers perceive that home prices are coming down, then they will stop making offers -- and home prices will come down."

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The median new home price dropped by 6 percent in July, to the lowest levels (on a nominal basis) since October 2003. Price erosion was not as great for resales, thus affordability is on par with late 2008 and mid 2009.

On average, the seasonally adjusted S&P/Case-Shiller home price composite indices exhibited very modest gains between May and June. Prices in eight metro statistical areas advanced while 11 declined.

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David Blitzer, chair of the Index Committee at Standard & Poor's, is concerned the modest upward trend in prices is set to reverse. “While [these] numbers are upbeat, other more recent data on home sales and mortgages point to fewer gains ahead,” Blitzer said. “The worry starts when you remember that the Homebuyers’ Tax Credit has expired, foreclosures are still at high levels, and July data on home sales and starts were very, very weak. The inventory of unsold homes and months’ supply data were particularly troubling. If this relative weakness in demand continues, it will likely filter through to home prices in coming months.”