Spotlight on Oil Overview:
Oil and other energy prices played a major role this week. The June Consumer Price Index (CPI) surged 1.1 percent, posting a year-over-year gain of 4.9 percent -- the biggest since May 1991. The Producer Price Index (PPI) jumped 1.8 percent in June from the previous month and 9.1 percent from last June -- the largest year-over-year gain since June 1981. Energy prices were the main culprit for both strong retail and wholesale headline inflation.
The effect of rising energy prices was also evident in June retail sales, which rose only 0.1 percent, despite a 4.6 percent jump in sales at gasoline stations as gas prices soared. For the second quarter, retail sales grew 2.6 percent -- the slowest quarterly pace since the fourth quarter of 2002. The published retail sales data from the Commerce Department are adjusted for seasonal factors but not for inflation. Using the goods component of the CPI to adjust for inflation, retail sales declined in the second quarter.
A separate report this week from the Bureau of the Labor Statistics showed that incomes are not keeping up with prices. Inflation-adjusted average weekly earnings fell 0.9 percent in June from May and were down 2.4 percent from last June. Manufactures also reported sharp increases in the prices they paid for inputs, according to the Philadelphia Federal Reserve manufacturing survey, which showed that the price-paid index rose to its highest level since 1980.
On Wednesday, the Fed released the minutes from the Federal Open Market Committee (FOMC) meeting on June 24-25, which showed that some members believed that downside risks to growth had diminished while the upside risks to inflation had increased. These members argued that a rate hike “would be appropriate very soon.”
In his semiannual Monetary Policy report to Congress on Tuesday and Wednesday, Fed Chairman Ben Bernanke confirmed the inflation view in the FOMC minutes, noting that upside inflation risks have “intensified,” given elevated energy and commodity prices and the declining dollar. Bernanke was especially concerned that potential pickup in inflation expectations may lead to wage increases during the “wage- and price-setting process.” However, Bernanke did not reiterate the view in the FOMC statement that downside risks to growth have diminished. Instead, he argued that there are “significant” downside risks to growth outlook, due to the possibility of higher energy prices, tighter credit market and a deeper housing decline.
Good news for the week was the sharp drop in crude oil futures: about $16 in three days, bringing the price below $130 a barrel on Thursday for the first time in more than a month. Crude rebounded slightly on Friday, hovering around $130 a barrel. Declining crude prices spurred some hopes that headline inflation will moderate in the coming months, making it easier for the Fed to keep interest rates on hold for some time. Fed funds futures showed about a 40 percent chance of a 25 basis-point increase in the target rate in September.
Finally, housing news continued to be downbeat. Single-family housing starts declined in June to the lowest level since January 1991. The surge in multifamily starts reflected a rush to start building activity before more stringent local building code changes took effect in New York. Home builders were more pessimistic in July in the face of weakening job markets, rising energy prices and declining home prices, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index, which declined to a record low in the 22-year history of the survey.
Interest Rates:
Stock markets rose and lifted major averages from bear market territory, driven by gains on financial stocks including Wells Fargo, JPMorgan Chase & Co and Citigroup, which released better-than-expect financial reports. In addition, declining crude oil futures extended the equity market rallies. Treasury prices declined and yields rose as investors’ risk appetite increased, making the safety of government bonds less attractive. The yield on the 10-year Treasury note stayed around 4.06 percent by mid-Friday afternoon -- 10 basis points higher than the rate on the previous Friday and the highest rate in three weeks.
Housing and Mortgage Indicators:
Total housing starts unexpectedly jumped, reflecting a rush to start building activity before local building code changes took effect in New York. Total housing starts advanced 9.1 percent in June to a seasonally adjusted annualized rate (SAAR) of 1,066,000. Single-family starts dropped 5.3 percent. Multifamily starts were up 42.5 percent as starts surged in the Northeast due to a change to New York City building codes.
Last June, the city enacted a new set of construction codes effective for permits authorized as of July 1, 2008, which caused a surge in multifamily building permits in order to avoid more stringent regulations (including additional on-site water supply, fire alarm voice systems, and wider stairwells). The Commerce Department estimated starts as a ratio to the permits data and thus the rush to file for permit authorizations translated directly to a surge in housing starts. Excluding the Northeast multifamily data, housing starts fell 4.0 percent in June, according to the Commerce Department.
Total starts increased 102.6 percent in the Northeast and edged up 0.4 percent in the South. Starts dropped 10.5 percent in the Midwest and 8.2 percent in the West. The bulk of the jump in starts in the Northeast likely borrowed from those that would have occurred in future months and thus starts in the region should post sharp drops in the near term.
Through the first half of this year, single-family starts were 40.4 percent lower than those in the first half of 2007. By contrast, year-to-date multifamily starts were 13.7 percent higher than those last year.
While housing starts continued to trend down since their peak at the beginning of 2006, the decline has moderated over the past year. For the second quarter, total housing starts fell 13.4 percent (annualized rate), compared with a decline of at least 30 percent in each of the previous three quarters. Single-family starts drop 28.0 percent during the second quarter, also the smallest decline since the second quarter of 2007. This indicated that residential investment was a smaller drag to economic growth in the second quarter after subtracting more than one percentage point from real gross domestic product growth in each of the prior three quarters.
Total permits rose 11.6 percent in June, driven by a 73.0 percent jump in permits in the Northeast. Excluding the Northeast multifamily permits, total permits rose 0.7 percent. Single-family permits -- a leading indicator for single-family housing activity -- dropped 3.5 percent. This marked the 14th decline over the past 15 months. Single-family permits fell in all four regions.
The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) declined to 16 from 18 in June, which was a record low that matched the level in December 2007. This marked the third consecutive decline in the index. (Readings below 50 indicates that more respondents view conditions as poor.)
The survey asks builders for their sentiments on current sales, traffic of potential buyers, and projected sales over the next six months. All three components fell to record lows in July. The index gauging current sales conditions fell to 16 from 17 in June, while the index gauging traffic of prospective buyers fell four points to 12. The index gauging sales expectations for the next six months dropped to 23 from 27 in the prior month. Regionally, the Northeast posted an increase from its record low in June while the rest of the regions saw declines.
Deteriorating job markets, rising energy costs and declining home prices aggravated by the rising foreclosures have caused many prospective buyers to remain on the sidelines, according the NAHB, which is calling for urgent actions from Congress to address “the worsening housing slump and the near-meltdown in financial markets last week.”
Economic Indicators:
The Producer Price Index (PPI) rose 1.8 percent, following a 1.4 percent increase in May. Large increases in food and energy prices drove the overall increase. Over the past year, the PPI rose 9.1 percent -- the largest gain since June 1981.
Excluding food and energy items, the core PPI was up a modest 0.2 percent for the second consecutive month. From a year ago, the core PPI rose 3.1 percent -- the largest gain since December 1991.
Retail sales edged up 0.1 percent in June, following a 0.8 percent gain in May. Despite nearly $50 billion of stimulus checks distributed during the month, retail sales posted the weakest increase since the 0.2 percent decline in February. A 3.3 percent drop in auto sales was responsible for the decline. Excluding autos, retail sales increased 0.8 percent -- the slowest pace in three months.
Sales at gasoline stations surged 4.6 percent. Housing-related sales, including those at building supply, appliances and furniture stores, saw sharp drops. Sales rose at apparel, sporting goods and hobby stores. Sales also increased strongly at grocery stores, driven by higher prices.
Retail sales excluding autos, gasoline and building materials -- the portions used to calculate the consumer spending component of gross domestic product (GDP) -- rose 0.3 percent, decelerating from a 0.7 percent increase in May and a 0.9 percent increase in April. Retail sales account for about 40 percent of total consumer spending, with spending on services accounting for the rest.
The Consumer Price Index (CPI) rose 1.1 percent in June after a 0.7 percent gain in May. This was the biggest increase since September 2005 at the aftermath of Hurricane Katrina and the second biggest gain since June 1982. A 6.6 percent jump in energy prices led the increase in the headline CPI. Food prices increased 0.8 percent over the month. Over the past year, the CPI increased 4.9 percent.
Excluding the volatile food and energy items, the core CPI rose a strong 0.3 percent. Rents, which accounted for almost 40 percent of the core CPI, rose 0.3 percent after a 0.1 percent gain in May. Over the past year, the core CPI was up 2.4 percent, accelerating from 2.3 percent in May.
Industrial production -- the nation’s output from factories, mines and utilities -- was up 0.5 percent in June, following a 0.2 percent drop in May.
Unseasonably hot weather likely drove utilities, which rose 1.1 percent. Mining output also increased strongly by 2.1 percent. Manufacturing output, which accounts for about four-fifths of industrial production, gained 0.2 percent, thanks to increased auto production as the protracted strike at American Axle was resolved in late May. Manufacturing production outside of motor vehicles fell 0.1 percent.
The industrial production report showed that capacity utilization, which measures a portion of plants in use and a gauge for inflationary pressures, rose to 79.9 percent from 79.6 percent in May -- the first increase since March. Industrial production is one of the five monthly indicators (including monthly gross domestic product) that the National Bureau of Economic Research tracks to date recessions and expansions. Because of its large increase in June, industrial production has dropped only 0.3 percent since peaking in December 2007.
Next week:
Monday — The Conference Board Index of Leading Indicators
Tuesday — The Office of Federal Housing Enterprise Oversight (OFHEO) Purchase-only House Price Index
Thursday — June existing home sales
Friday — June new home sales and June durable goods orders
Orawin Velz
Associate Vice President, Economic Forecasting
July 18, 2008