LOOKING AHEAD

Industrial Production

The Federal Reserve releases the Industrial Production report each month. It is a real measure of output from manufacturing, mining, electric, and gas utilities. The data is significant in that it provides an indicator of the state of the economy. Analysts use the data to attempt to determine market direction. The Fed uses the data to help set the course for monetary policy. Generally the Fed likes to see steady growth in the economy with little price pressures.

Mortgage interest rates generally react favorably to weaker than expected industrial production data. In times of economic weakness investors often move out of stocks and into mortgage bonds. When things look good investors often move out of bonds and back into stocks. We have seen these patterns frequently in recent months. Floating into significant economic data always has some risk involved. Now is a great time to take advantage of mortgage interest rates at these historically low levels.

LOOKING AHEAD

Oil

Inflation fears tied to rising energy prices remain on the minds of traders.  Inflation, real or perceived, erodes the value of fixed income investments such as mortgage-backed securities, causing prices to fall and rates to rise.  Tensions with Iran over sanctions tied to their nuclear activities increase concerns that they will reduce their oil supplies to the world.  Last week OPEC Secretary General Abdullah el-Badri indicated, “We’re working hard to bring down the price.  We’re not comfortable.”  OPEC indicates they are comfortable with oil around $100 per barrel.  U.S. consumers are comfortable with price targets considerably lower than that.  Unfortunately that doesn’t look to be a possibility at this time.  OPEC blames rising prices on excessive speculation and noted they have been able to meet consumer needs.

Oil prices have fallen in the short term following signs of slowing US economic growth, reports that US inventory supplies are at record highs, and weakness in China’s demand. Falling energy prices are generally good for mortgage interest rates.  The great news is that mortgage interest rates remain very favorable.  Now is a good time to take advantage of these low rates to avoid any uncertainty with the future.  The current rates are a sure thing while waiting for the possibility for lower rates is risky.

LOOKING AHEAD

PCE

The US Department of Commerce’s Bureau of Economic Analysis releases the core PCE price index.  The report provides the average increase in costs for personal consumption expenditures excluding food and energy.  As of July 2009 the figure now includes food services in the figure.

The report is significant in that the Fed uses the PCE in determining inflation as opposed to the prior use of the consumer price index.  The reports vary in that the CPI in that the PCE includes the price of spending for and on behalf of households.  This includes health care spending paid for a household by a business.  The CPI only reflects out of pocket expenses paid directly by consumers.

The Fed noted last week that inflation in the short term has escalated.  However, they also indicated that long term inflation projections show tame expectations.

Mortgage interest rates will likely spike higher in the short term if the PCE core reading is higher than expected.  A reading in line with expectations will likely help rates stay in check.

LOOKING AHEAD

Bernanke Press Conference The Fed meets with results Wednesday afternoon. In an effort to increase transparency Fed Chairman Bernanke will hold a press conference following the results. This was a major change in Fed protocol implemented last year. Prior meetings had the Fed announce the results with only a brief statement. Bernanke’s foreign counterparts regularly hold press conferences. However, many analysts and even Fed officials themselves have concerns about this press conference. The worry is that while the Fed is expected to keep things in check, Bernanke may unintentionally say something that rattles the financial markets. Bernanke will try his best not to cause instability but the press conference will definitely be an event to watch carefully.

LOOKING AHEAD

Retail Sales

Retail sales data is the first indication of weakness or strength in consumer spending released each month.  The Bureau of the Census of the US Department of Commerce provides information on how much the consumer spends on the purchase of goods.  This data provides the consumption part of the gross domestic product.  Retail sales data represents merchandise sold for cash or credit by retailers.  Durable goods, such as autos, make up 35% of the figure.  The balance consists of non-durables such as gasoline, restaurants, and general merchandise.

There are several drawbacks to the report.  The data covers purchases of goods only, not services.  It is also not adjusted for inflation and is extremely volatile.  Economists are concerned that the current economic uncertainty will continue to curtail consumer-spending habits.  Consumers have generally been given credit for sustaining the economy even amid the economic turmoil.

Consumer Price Index The Consumer Price Index is widely accepted as the most important measure of inflation. The CPI is a measure of prices at the consumer level for a fixed basket of goods and services. The National Statistics Office and the Bureau of Agricultural Statistics of the Department of Agriculture collect price data for the computation of the CPI. Since it is an index number, it compares the level of prices to a base period. By comparing the level of the index at two different points in time, analysts can determine how much prices have risen in that period. Unlike other measures of inflation, which only factor domestically produced goods; the CPI takes into account imported goods as well. This is important due to the ever-increasing reliance of the US economy upon imported goods. Analysts primarily focus on the core rate of the CPI which factors out the more volatile food and energy prices. High oil prices remain a concern from an inflation perspective. Record debt levels continue to weigh heavily upon the financial markets as well. Inflation, real or perceived, erodes the value of fixed income securities such as mortgage bonds. Rates have a better chance of falling with lower than expected CPI figures.

LOOKING AHEAD

ADP Employment 

The ADP employment report is a measure of employment derived from data of roughly 500,000 US businesses.  The survey focuses on the private sector of the economy.  In contrast, the Bureau of Labor Statistics releases the regular employment report which includes both private and government employment statistics.

The ADP employment report has gained more prominence lately in that it is delivered prior to the Friday employment report.  This gives analysts an improved forecast heading into the payrolls component of the employment report later in the week.

The Fed is usually focused on keeping inflation in check.  Tightening employment conditions can result in wage inflation.  The ADP report provides solid data on these conditions.  Despite this, the data still can diverge from the regular employment report.  The employment report is derived from a household survey and an establishment survey.  These surveys often differ from one another and from the ADP employment report in that they are based on different data sets.  There are no guarantees that the most important employment report the first Friday of each month will mirror the ADP report released 2 days prior.  With this in mind floating into the data is always very risky.  Now is a great time to take advantage of mortgage interest rates at these historically favorable levels to avoid future market volatility.

Income and OutlaysThe personal income and outlays release is a monthly report issued by the Bureau of Economic Analysis (BEA). The data is important because it is thought to provide a solid indication of future consumer demand. The personal income component is primarily a measure of wages and salaries. The outlays component is primarily a measure of spending on goods and services. Together the figures provide analysts valuable insight into consumer economic standing and consumption. The prior release showed an income increase but not as much as analysts expected. Generally stagnant wages coupled with tighter borrowing restrictions make it difficult for consumers to spend money. It is important to note that no single economic indicator can consistently predict the future of the economy. However, the personal income and outlays report is a closely watched release. The consumer remains a vital component of the US economy. The data this week has the potential to cause mortgage interest rate volatility. Now is a great time to take advantage of low rates.

LOOKING AHEAD

LEI

The index of leading economic indicators (LEI) is a weighted average of eleven economic variables that “lead” the business cycle.  It is constructed for forecasting future aggregate economic activity.  The eleven variables that make up the LEI measure workers’ hours, initial unemployment claims, new factory orders, vendor performance, contracts and orders for plant and equipment, new housing permits, changes in unfilled orders, prices of raw materials, stock prices, money supply and consumer expectations.

Each of the variables that comprise the index has a tendency to predict (or lead) economic activity.  For example, new orders for manufactured goods, new orders for plant and equipment, and new building permits are all direct measures of the amount of future production being planned for the economy.

Analysts monitor the LEI in an effort to predict future economic growth.  When the LEI report is up, mortgage market participants expect credit demand to increase and inflationary pressures to build.  Thus, when the LEI report is rising, interest rates tend to rise as well.

The LEI report is a valuable forecasting device that correctly predicts most economic turning points.  The percentage change in the LEI is reported monthly and is an indication of the activity that will occur within the next three to six months.  The LEI tends to turn down before peaks in the business cycle.  Continuous declines are generally accepted as evidence that a recession continues.

Nine of the eleven components that make up this index are known before the release of the report, so the index is easy for economists to predict.  Thus, although this is important predictive data for market participants, surprises are not common with the release of this data.

LOOKING AHEAD

Producer Price Index The producer price index is a measure of prices at the producer level and is important because it is the first inflation report to be released each month. Investors are typically able to gain an initial indication of inflationary pressures from the release. If producer prices are increasing, there is a tendency for producers to pass the increases on to consumers in the form of higher priced goods. It is important to note that the PPI is only a measure of goods, while the consumer price index is a measure of goods and services. It is possible for the price of goods to remain stable, while the price of services increases. In this scenario PPI would do little to warn of a change in inflationary pressures, while the CPI report would provide an indication of the inflationary effects of the service component. This distinction between the two reports shows why most analysts view the CPI as a more accurate indicator of inflation. Nevertheless, market participants still gain valuable insight into potential volatility in the financial markets from the PPI release. Be cautious heading into the inflation data this week.