Is The Fed Inching Closer To A Rate Cut?~31

RTTNEWS
8/18/2007 5:31:28 PM As the euphoria over Federal Reserve's bold step settles down, market participants are divided over whether the symbolic gesture of lowering discount rates mean anything significant to markets. The move signals that the central bank believes that the credit market squeeze poses material risks to growth. According to Wachovia Securities, even a significant cut in the federal funds target rate will not ensure the much-needed liquidity in the mortgage markets.

A discount rate is nothing but the rate at which banks borrow directly from the Fed. Unlike open market operations that call for Treasury bills and agency debt as security, the discount window accepts a wide range of securities, including asset-backed securities, commercial mortgage-backed securities and mortgage-backed securities. In addition to the reduction in the discount rate, the Fed also changed the standard terms of loans at the discount window to allow for borrowing up to 30 days against the usual overnight timeframe.

Following Friday's Fed move, Wachovia Securities said the probability of a Federal funds target rate cut before the September 18th meeting is now reduced. If the credit market recuperates, then even an interest rate cut at the September meeting looks unlikely. However, if the recent credit market turbulence hurts growth further and the core consumer price inflation continues to moderate, the Fed may resort to one or more interest rate reductions later this year.

The past week's economic readings were largely in-line with expectations and did not portend any weakness in growth. Among the reports released last week, retail sales revealed a 0.3% increase in July. Sales, excluding autos, were up a better than expected 0.4%. After auto and gasoline sales were stripped off, the gain was 0.6%. Almost all categories showed fairly good performances. Clothing store sales and sales at department stores rose 1.3% and 1.6%, respectively, suggesting that the concerns over a negative wealth effect pulling down retail sales are unfounded.

Business inventories rose 0.4% in June after increasing at a 0.5% rate in May. The pace of growth in retail inventories slowed to 0.5% in June from 0.7% in May. The inventories to sales ratio is below the highs of the last cycle and accordingly, Wachovia Securities expects inventory build up to add to economic growth in the second half of the year.

The trade gap revealed a narrower than expected deficit of $58.1 billion for June. Wachovia Securities expects the decline in the deficit to add 0.5% to second quarter GDP growth, which was originally reported as 4.2%. Export growth was bolstered by higher shipments of industrial supplies and materials to foreign countries. Another aspect of significance was that petroleum import prices remained flat.

The producer price inflation report suggested a 0.6% spike in wholesale prices in July. Energy prices climbed 2.5% in July, while food prices eased 0.1%. The core producer price inflation rate was 0.1%, which strengthens the case for a pause in the near term. Meanwhile, consumer prices were up 0.1% in July due to a fall in gasoline prices that offset to some extent the impact of higher food costs. The core consumer price inflation rate was 0.2%, rendering the annual gain to 2.2%. One encouraging aspect was the continued moderation in actual and implied rents.

Jobless claims for the recent reporting week unexpectedly rose, casting doubts on the job market's ability to hold up against the backdrop of slowing growth. The housing market data were also not that enterprising. Housing starts declined 6.1% in July to a seasonally adjusted annual rate of 1.381 million units. Building permits, an indicator of future housing activity fell 2.8% to 1.373 million units. With July's decline, housing starts and permits have dropped to levels that prevailed before the housing boom began back in mid-1997. Economists see a 0.5% hurt to GDP due to the softness in starts, while they also believe that the recent credit market turmoil could further impact housing starts, as financing becomes difficult for builders.

Meanwhile, the Philadelphia Fed's survey revealed that manufacturing conditions in the mid-Atlantic region stalled. The general business conditions index dropped to 0 in August from 9.2 in July, and the softness is also expected to have nationwide ramifications. However, the new orders index suggested expansion. On a surprising note, the employment and average workweek indexes expanded significantly. One can take comfort from the fact that the future general business conditions index rose to 5.8 points to 36.2.

The upcoming week's economic calendar is very light. The markets get to receive only a few second-tier economic reports. That said, the markets' pre-occupations continue to be the liquidity crisis and the tighter credit markets. The noteworthy reports scheduled to be released in the week are the new home sales and durable goods orders reports for July.

New home sales for July are unlikely to inspire the Street even if they reveal a surprising increase. Market participants are likely to view an increase in sales as a non-event, as they are most likely to have been achieved at the expense of prices. Of late, builders are forced to offer heavy discounts to push sales.

Avery Shenfeld from CIBC World Markets expects 1.4% growth in durable goods orders. Going by the strong order growth reported by Boeing (BA) for July, one can expect a solid increase in the volatile transportation orders. Nonetheless, orders for automobiles may continue to remain weak, given the waning consumer confidence. The all-important non-defense capital goods orders, excluding aircraft, are expected to show weakness, in-line with the recent trend. Accordingly, business capital spending is unlikely to offer much support to GDP growth in the near term.

Apart from these reports, the markets may also focus on the Conference Board's leading indicator index for July, the customary weekly jobless claims data for the week ended August 18th and the weekly crude oil inventory report.

Wachovia Securities expects the leading index to show a significant increase in July due to positive contribution from initial claims, consumer confidence, money supply and supplier deliveries.

Monday

The Conference Board is due to release the leading index for July at 10 AM ET on Monday. The index is expected to show a 0.3% increase for the month.

In June, the leading index fell 0.3% in June, reversing the gain of May. The Conference Board noted that the index was lower in four out of the past six months. The largest negative contributions in the month were from housing permits, initial claims for unemployment insurance and consumer expectations. However, the leading and lagging indexes rose 0.2% and 0.5% in June.

Tuesday

Richmond Federal Reserve Bank President Jeffrey Lacker is scheduled to speak about the U.S. economic outlook in Charlotte, North Carolina at 12:30 PM ET on Tuesday.

Wednesday

The Energy Department's weekly Crude Oil Inventory report is scheduled to be released at 10:30 AM ET on Wednesday.

Crude oil stocks fell 5.2 million barrels in the week ended August 10th to 335.2 million barrels. Notwithstanding the decline, inventories remain above the upper end of the average range for this time of the year. Gasoline stocks declined 1.1 million barrels, and they remain below the lower end of the average range. Meanwhile, distillate inventories edged up 0.2 million barrels and are in the middle of the average range for this time of the year.

The average refinery capacity utilization over the last four weeks was 92.1% compared to 91.9% in the previous week and 92.7% in the year-ago period.

The price of WTI grade crude oil was $71.49 a barrel as of August 10th, down 5.2% from $75.41 a barrel last week and about 3.9% lower than in the year-ago period. The average nationwide price of regular grade gasoline was $2.771 a gallon as of August 13th compared to $2.838 as of August 6th, 2007 and $3 as of August 14th, 2006.

Thursday

The weekly jobless claims for the week ended August 17th are scheduled to be released at 8:30 AM ET on Thursday.

Jobless claims increased 6,000 in the week ended August 11th to 322,000 from the previous week's unrevised average of 316,000. Economists expected jobless claims to have eased to 315,000.

The less volatile four-week moving average increased 4,750 to 312,500 from the previous week's unrevised average of 307,750. Continuing claims for the week ended August 4th increased to 2.548 million from the preceding week's revised level of 2.547 million.

Friday

The Durable Goods Orders Report, which sheds light on the new orders placed for big-ticket items that last for more than 3 years, is expected to be released at 8:30 AM ET on Friday. Economists expect the report to reveal 1% growth in durable goods orders for July.

Last month, new orders for manufactured durable goods rose 1.3% following a 2.4% decline in May. The bulk of the increase was due to a 7.1% increase in new orders for transportation equipment. Shipment of durable goods fell 1.2%, while unfilled orders rose 1.4%. Inventories edged up merely 0.1%.

Data on New Home Sales, which measures the number of newly constructed homes with committed sale during the month, is scheduled for release at 10 AM ET on Friday. Economists forecast new home sales of 830,000 units for July.

In June, new home sales slid 6.6% to 834,000 from 893,000 in May. Annually, new home sales declined 22.3%. The median sales price of new homes was $237,900, down 2.2% from $243,200 in the year-ago period. New home inventories at the end of June represented a supply of 7.8 months compared to 7.4 months in May and 6.4 months in June 2006.