US new home sales fall but little sign of liquidity shortfall elsewhere

Evidence of a slowing US housing market continues to accumulate. From Reuters:

Sales of new U.S. homes fell 5 percent in January to their slowest pace in a year while the number of homes on the market hit a record high, according to a government report on Monday that signaled further cooling in the housing market.

However, the slide in prices was halted.

Home prices, however, have been more resilient, and economists chalk that up to stubborn sellers trying to cash out at the market's highs. For January, Commerce Department data show the median home sales price rose 4 percent to $238,100, for example.

A graphical representation of the trends can be found at Calculated Risk.

Across the Atlantic, in contrast, the UK housing market continues its recovery. From another Reuters report:

House prices rose for a third consecutive month in February and at the fastest pace since June 2004, according to property consultant Hometrack's latest survey published on Monday.

It said that prices rose by 0.4 percent during February, bringing the average cost of a home to 161,700 pounds, although prices were still down 0.5 percent on a year earlier.

And from yet another Reuters report on UK home loans:

Mortgage approvals -- the number of loans agreed but not yet completed -- totalled 45,039 last month. That was 32 percent higher than January 2005, but weaker than December's 51,233.

The figures are not adjusted to reflect seasonal patterns in the housing market, which means they can be volatile from month to month. Still, analysts said the figures showed the property market remained in rude health.

Which all suggest that rate cuts by the Bank of England might well come a bit later than many are anticipating.

And for all the talk about interest rate increases elsewhere and the unwinding of carry trades -- see for example, this article entitled "Global credit ocean dries up" -- money supply in the euro area continued to grow at a robust pace in January, with M3 growing at an annual rate of 7.6 percent.

US durable goods orders fall in January

The US durable goods orders data for January look weak. From Reuters:

New orders for U.S.-made durable goods plunged 10.2 percent in January, the biggest drop in 5-1/2 years, as non-defense aircraft orders posted their largest fall since December 1998, a government report showed on Friday.

Outside transportation, orders for expensive items built to last three years or more posted their third straight monthly gain, rising a slightly larger-than-expected 0.6 percent, the Commerce Department report showed...

December orders were revised up to a 2.5 percent gain from the originally reported 1.3 percent advance...

Capital goods orders tumbled 23.1 percent, the biggest slide since July 2000, on a record 20 percent decline in non-defense capital goods orders and a 64.3 percent fall in defense capital goods orders.

Non-defense capital goods orders excluding aircraft, seen on Wall Street as a proxy for business spending, edged down 0.4 percent, the report showed...

Unfilled orders, which can signal future strength of factory production, fell 0.8 percent, the largest drop since a decline of 1.2 percent in October 2002.

If business spending is weak in the US, it isn't much better in the UK, as Edward Hugh notes. From FT:

The volume of business investment fell by 1 per cent in the last three months of 2005, compared to the previous quarter. The Office for National Statistics said that for the year as a whole, the volume of business investment was £113.1bn, up 1.6 per cent on 2004, against growth of 3.3 per cent in 2004.

However, higher consumer spending helped boost UK fourth quarter GDP growth to a one-year high, reports Reuters.

The Office for National Statistics said its first estimate for GDP growth in the fourth quarter of 2005 was unchanged at 0.6 percent but that it had nudged up the annual rate a tenth of a point to 1.8 percent. Economists had predicted no revision.

Household spending rose by 0.7 percent in the fourth quarter, its fastest pace in more than a year, lending credence to Bank of England forecasts that consumers are poised to drive economic recovery over 2006.

Japan's trade balance falls into deficit, German confidence up

A trade deficit is not something you normally associate with Japan, but it happens now and then. From Reuters:

Japan logged a monthly trade deficit for the first time in five years in January as high oil prices boosted imports and the Lunar New Year dampened shipments to Asia, now Japan's largest export market.

Japan's trade balance fell to a deficit of 348.9 billion yen ($2.95 billion) in January from a surplus of 914.0 billion yen in December, Ministry of Finance data showed on Thursday. That compared with a consensus forecast of a 100 billion yen deficit...

Exports rose 13.5 percent from a year earlier to 5.01 trillion yen, while imports rose 27.0 percent to 5.36 trillion yen...

Seasonally adjusted, the trade balance was a surplus of 572.26 billion yen, down from 587.86 billion yen in December.

Economists are not too concerned about the January trade balance as other indicators show that economic growth will be sustained, continued deflationary pressure notwithstanding.

The Ministry of Economy, Trade and Industry said its tertiary sector index, which gauges activity in the broadly defined services industry, rose 0.2 percent in December from the previous month to mark its highest level on record... The all-industries index, which covers a broader range of economic activity and includes the tertiary index, rose 0.4 percent from the previous month, also scaling a record high.

Separately, the Bank of Japan said its domestic corporate services price index (CSPI) fell 0.8 percent in January from the previous month [and] was down 0.1 percent from a year earlier.

Things are also looking up in Germany. From Bloomberg:

The Ifo confidence index, based on a monthly survey of 7,000 companies, jumped to 103.3 from 101.8 in January. Economists expected the index to dip to 101.5, according to the median of 20 forecasts in a Bloomberg News survey. German consumer confidence rose to an 11-month high, the GfK research company said today.

And in the US, initial jobless claims fell last week. From Reuters:

First-time claims for state unemployment aid dropped to 278,000 in the week ended February 18 from an upwardly revised 298,000 the prior week, the Labor Department said. The number remained under 300,000 for the sixth straight week, the longest stretch in more than five years... The four-week moving average of initial claims...fell to 281,750 from 283,250...

In a separate report that gauges change in the supply of jobs, the Conference Board, a private business research group, said its help-wanted index slipped to 37 in January from 38 in December.

Inflation comes with strong economy, but not in China

US inflation accelerated in January.

Consumer prices surged 0.7 percent last month, above Wall Street forecasts for a 0.5 percent increase, as energy costs soared. But the closely watched core Consumer Price Index, which excludes volatile food and energy costs, rose just 0.2 percent, matching expectations...

Over the past year, consumer prices have climbed 4 percent, the largest 12-month increase since October 2005 and an acceleration from December's 3.4 percent increase... On a year-over-year basis, core prices were up 2.1 percent, however, a slowdown from December's 2.2 percent increase and in-line with Wall Street forecasts...

In a separate report, the Labor Department said real average weekly earnings fell 0.2 percent in January, the first decline since September, after a 0.5 percent gain in December. Average weekly earnings have risen 3.6 percent since January 2005, but since inflation has risen even faster, real earnings remain 0.4 percent lower than a year earlier.

Markets, however, apparently focused on the core inflation rate.

Major U.S. stock indexes rose, with traders focusing on the core CPI and a more than $1 drop in oil prices. Treasury debt prices also rose, while the U.S. dollar pared gains following the report.

However, Michael Bryan, posting at the macroblog, "looked at the data sliced a number of different ways and they tell a pretty consistent story—they seem to be inching a little higher".

That would be consistent with how the global economy has generally been performing, which is strong.

Industrial new orders in Europe continued on an uptrend in December.

The euro-zone industrial new orders index rose by 2.5% in December 2005 compared to November 2005. The index increased by 5.3% in November3 and decreased by 0.5% in October. EU25 new orders grew by 2.3% in December 2005, after rises of 3.8% in November and 0.1% in October.

February factory orders from the UK also shows improvement.

The Confederation of British Industry said its monthly manufacturing order books balance was -18 in February after -28 in January.

That compared with analysts' forecasts for a reading of -25 and a big improvement on the average of -26 over the last six months...

The slowing decline in orders boosted firms' expectations for future output, with the balance rising to +10, the highest since February 2005, from +1 in January.

Sentiment in Europe is optimistic.

An index of sentiment of French manufacturers rose to 105, the most since January 2005, from 103, said Insee, the national statistics office, in Paris today. An Italian consumer confidence gauge climbed to 110, the highest since September 2002, from a revised 106.5, the Rome-based Isae Institute said.

And yet, the hottest economy of all is not seeing much inflation.

China's consumer price index (CPI) rose by 1.9 percent in January from the same month last year, the National Bureau of Statistics (NBS) said Wednesday.

Producer prices reported a day earlier would have provided an inkling.

China's industrial producer prices increased by 3.1 percent in January over the same period of 2005, the National Bureau of Statistics said (NBS) Tuesday...

Producer prices for consumer products, however, slid by 0.3 percent...

That apparently leaves the People's Bank of China uncertain over China's future price trend.

US leading index jumps, European growth forecast upgraded, FDI in China rises

Prospects for the world economy in 2006 continue to look good.

In the US, the Conference Board's leading index jumped in January.

The Conference Board announced today that the U.S. leading index increased 1.1 percent, the coincident index increased 0.2 percent and the lagging index increased 0.7 percent in January...

The leading index now stands at 140.1 (1996=100). Based on revised data, this index increased 0.3 percent in December and increased 0.9 percent in November. During the six-month span through January, the leading index increased 2.3 percent, with nine out of ten components advancing (diffusion index, six-month span equals ninety percent).

The minutes from the last FOMC meeting suggests that the Federal Reserve is not too concerned about growth in the US.

Although the stance of policy seemed close to where it needed to be given the current outlook, some further policy firming might be needed to keep inflation pressures contained and the risks to price stability and sustainable economic growth roughly in balance.

Europe is also expected to see continued growth.

The economies of Germany, Britain and France will grow faster than expected this year, Joaquin Almunia, EU monetary affairs commissioner, said on Tuesday, but he warned that bird flu could pose a threat to the European recovery.

Mr Almunia predicted that European Union growth would reach 2.2 per cent this year, up from the 2.1 per cent he predicted last autumn...

In spite of poor growth in the fourth quarter of 2005, Mr Almunia left unchanged his growth forecast for the 12-country eurozone at 1.9 per cent.

And foreign direct investment to China looks likely to help keep that country's rapid growth going for at least a while more.

Foreign direct investment (FDI) to China in the first month rose nearly 11 per cent from a year earlier, the Ministry of Commerce said yesterday, showing foreign investors attracted to the large export base and huge consumption market are not losing steam.

The total FDI in January was US$4.55 billion, up 10.99 per cent compared to US$4.1 billion last January.

German producer prices, UK house prices and M4, and Canadian leading index all up

German retail sales may have been down 0.8 percent in real terms in December, but other data show that the world economy is still running hot.

In Germany itself, producer prices were up strongly in January.

Producer prices in Germany rose 1.2 pct in January from December and rose 5.6 pct from a year earlier, the Federal Statistics Office said.

In the UK, house prices are up.

In further evidence of a firming housing market, property web site Rightmove said asking prices rose 2.7 percent in the early January to mid-February survey period compared with the prior survey, taking the average asking price to 201,600 pounds.

But the figures are not adjusted to account for the seasonal recovery in the property market at the start of the year. In annual terms, asking prices rose 4.0 percent compared with a gain of 3.6 percent year-on-year gain in the prior survey.

The monthly rise marked the highest asking price and first move above 200,000 since the survey began in August 2001, Rightmove said.

M4 grew at a double-digit annual rate in January.

The Bank of England said M4 money, a broad measure of money supply, increased by 0.5 pct in January from December on a seasonally adjusted basis, for an 11.7 pct year-on-year rise.

M4 lending, though, was well below expectations.

Meanwhile, M4 lending during the month increased by 8.9 bln stg, well below expectations for a rise of 23.0 bln and compared with a rise of 23.9 bln stg the previous month.

Across the Atlantic in Canada, the economic outlook appears good.

The composite leading index grew 0.5% in January, almost matching its 17-month high gain of 0.6% in December. Very strong gains in the stock market and housing starts at the start of the year gave a boost to the overall index. These increases offset continued sluggish export demand for manufactured goods.

But the airlines industry reminds us that good times are often followed by bad times.

The head of the world's airline club warned the industry against the danger of overcapacity on Monday, ahead of an air show at which carriers are expected to add to the record aircraft orders they booked last year.

Airlines might need more capacity as markets such as India rapidly expanded, but the industry had to learn from earlier periods in which it found itself with too many planes, said Giovanni Bisignani, director general of the International Air Transport Association.

"The industry cannot afford the negative impact of overcapacity," Bisignani told a conference in Singapore a day before the scheduled opening of the Singapore air show.

Japan grows at 5.5 percent rate in fourth quarter

The world economy continues to grow and -- unusually in recent years -- it is being led by Japan.

The Japanese economy stepped up a gear with 5.5 percent annualized growth in the fourth quarter of 2005 as rising consumer spending helped keep the recovery firmly on track.

Japan's economy grew four times faster than the United States which saw annualized growth of 1.1 percent in the same period.

It was the fourth straight positive quarter and reinforced hopes that the world's second-largest economy is finally on a sustainable recovery path after a slump stretching back over a decade.

Quarter-on-quarter, Japan's gross domestic product (GDP) grew 1.4 percent, beating market expectations for 1.2 percent and significantly stronger than the 0.3 percent pace seen in the third quarter of 2005.

In Europe, industrial production continued to trend up in December.

Seasonally adjusted industrial production rose by 0.1% in the euro-zone in December 2005 compared to November. Production grew by 1.4% in November, but fell by 0.7% in October. Output in the EU25 rose by 0.3% in December 2005, after an increase of 1.1% in November and a decrease of 0.6% in October.

In December 2005 compared to December 2004, industrial production rose by 2.5% in both the euro-zone and the EU25.

And in the US, producer prices continued to rise in January.

The Labor Department said U.S. producer prices rose by 0.3 percent in January while core prices excluding food and energy climbed 0.4 percent. The latter was twice market expectations and the fastest wholesale inflation rate since January 2005.

Not everything is hot, though.

The University of Michigan said its preliminary index of consumer sentiment in February fell to 87.4 from 91.2 in late January.

US and UK housing markets look strong in January, may not be sustained

CEOs in the US are getting more optimistic. Strong manufacturing activity reported by the Federal Reserve Bank of Philadelphia and a surge in US housing starts in January would seem to justify the optimism, but it is not all good news from the US, as Reuters reports.

Construction of homes in the United States soared in January to the highest in nearly 33 years thanks to mild winter weather, the government said on Thursday in a report showing unexpected strength in housing...

The Commerce Department said housing starts hit a 2.276 million unit annual rate in January, above Wall Street forecasts of a 2.0 million unit pace. December starts were revised up to a 1.988 million unit pace from an originally reported 1.933 million unit rate.

January's 14.5 percent rise was the largest monthly percentage gain since March 1994, when starts rose 17.0 percent...

Permits for future construction, an indicator of builder confidence, posted an unexpected increase, up 6.8 percent to a 2.217 million unit rate from December's 2.075 million pace. Economists had expected a decline to a 2.062 million pace...

A separate report from the Labor Department showed U.S. import prices climbed an unexpectedly steep 1.3 percent in January as the cost of imported petroleum shot up 6.4 percent, its first increase in fourth months.

The rise in import prices, which followed a revised 0.1 percent December drop, outstripped expectations on Wall Street for a 0.9 percent gain. But non-petroleum import prices edged up just 0.2 percent last month.

Export prices rose 0.7 percent, ahead of the 0.2 percent gain economists had expected...

The Labor Department also said the number of Americans filing initial claims for unemployment benefits rose an unexpectedly large 19,000 last week but held below the 300,000 level for a fifth straight week for the first time in over five years, signaling a strong job market.

The department said 297,000 first-time claims for state unemployment aid were filed in the week ended February 11, up from a revised 278,000 in the prior week.

Economists polled by Reuters had expected a rise to 285,000 from the 277,000 originally reported for the prior week.

The increase pushed the four-week moving average of initial claims, which smooths weekly volatility to provide a better sense of job market conditions, up by 6,250 to 283,000.

It may be the weather, or the US housing market may be following the UK's, which seems to be benefiting from a second wind. Reuters reports:

House prices rose in the three months to January for a third straight period although the gains were modest, the Royal Institution of Chartered Surveyors said on Thursday.

The group said its house prices balance edged up to +9 in January from +8 in December. That was the highest since +18 in June 2004 but RICS cautioned rises were now only around half the long-run average pace.

There is not too much enthusiasm among economists for the UK housing market. From another Reuters report:

House prices are overvalued and the recent upturn in housing market activity will likely run out of steam towards the end of the year, a Reuters poll of economists shows...

The median forecast showed house prices, based on the main house price indices, will be 3.5 percent higher in the fourth quarter this year from the same period a year ago. But forecasts ranged widely from no growth to as high as 10 percent.

And UK retail sales seem to have trouble picking up again, based on the data for January.

The Office for National Statistics said [retail] sales volumes fell 1.3 percent on the month -- the biggest decline since December 2004 and sharply lower than forecasts for a 0.2 percent fall. The annual rate of 1.3 percent was the weakest in three months...

Indeed, even heavy discounting by retailers failed to bump up sales volumes last month. The retail sales deflator slipped to -1.2 percent in January from -1.1 percent in December -- suggesting the sharpest price falls in almost a year...

The ONS said the underlying trend rate of retail sales also eased, to 1.3 percent in the three months to January from 1.6 percent in the prior period.

Still, it said the overall trend was "reasonably upward" and had been steadily increasing since mid-2005.

Indeed, analysts expecting interest rates to remain steady or rise this year said January's data could be a mere blip.

US industrial output falls in January, but manufacturing grows

Warm weather in January boosted US retail sales (see yesterday's post) but held back industrial output. From Reuters:

U.S. industrial output fell 0.2 percent in January as warm weather slashed power usage, Federal Reserve data showed on Wednesday, but higher manufacturing production and strong capacity use fanned inflation fears.

Shortly after the report was released, new Fed Chairman Ben Bernanke told Congress that the U.S. economy was running so close to capacity that it faced increasing inflation risks that could require higher interest rates to tamp down.

The Fed said utility output fell 10.1 percent in January, the largest monthly decline in the 34-year history of the Fed's industrial production index.

But excluding output from utilities, January output from U.S. factories and mines would have been 0.8 percent higher, the Fed said...

While the weather-related fall in utility output caused closely watched industrial capacity utilization to dip to 80.9 percent, it still topped economists' forecasts for 80.8 percent utilization. December's capacity use rate was revised to 81.2 percent from a previously reported 80.7 percent.

And manufacturing capacity use was 80.5 percent in January, the highest level since July 2000...

A separate index report from the New York Federal Reserve indicated that manufacturing growth at New York state factories ticked higher in February, exceeding expectations, but the employment component of the index dropped.

The weather will be a factor for oil prices too. From Bloomberg:

Crude oil rose for the first day in four in New York after falling below $58 for the first time this year when a government report showed U.S. oil stockpiles jumped almost five times as much as analysts had expected.

Crude-oil supplies climbed 4.9 million barrels to 325.6 million last week, the highest since June, the Energy Department said yesterday. Oil fell as low as $57.60 a barrel, erasing gains that started late December on concern Iran may cut oil exports in the dispute over its nuclear program.

Outside the US, Japan's leading index has been revised up from a preliminary 80.0 percent to 81.8 percent.

US retail sales pick up, Europe GDP growth slows

US retail sales were strong in January. Reuters reports :

Retail sales surged 2.3 percent in January, nearly triple the expected increase and the largest gain since May 2004, a report on Tuesday from the U.S. Commerce Department showed. Excluding demand for cars and parts, retail sales were up 2.2 percent in the largest monthly rise in more than six years.

Both overall sales and sales outside the auto sector were far stronger than Wall Street had expected, and analysts said usually warm winter weather and gift cards -- which are rung up when they are redeemed rather than sold -- likely exaggerated the shopping strength...

The higher-than-expected sales growth in January was offset slightly by a downward revision to December's data. Sales were up just 0.4 percent in December, rather than the initially reported 0.7 percent gain. The rise in sales outside the auto sector was unrevised at 0.2 percent in December...

Sales were 0.4 percent lower last week according to the International Council of Shopping Centers and UBS Securities LLC, while Redbook Research showed sales were up 0.3 percent so far in February...

The Commerce Department said U.S. business inventories climbed 0.7 percent in December, above the 0.5 percent growth expected by Wall Street, while November's gain was revised up to show a 0.6 percent rise instead of the initially reported 0.5 percent gain. Together, the increases could prompt upward revisions to fourth-quarter growth.

Meanwhile, Europe, like the US, reported a slowdown in GDP growth in the fourth quarter of last year.

GDP grew by 0.3% in the euro-zone and by 0.4% in the EU25 during the fourth quarter of 2005, compared to the previous quarter, according to flash estimates published by Eurostat, the Statistical Office of the European Communities. In the third quarter of 2005, growth rates were +0.6% in both zones.

Germany, in particular, saw no growth in the quarter. The UK did better, growing 0.6 percent, with low inflation to boot -- 1.9 percent in January and December.

The outlook is better, though. From Bloomberg:

German investors and executives expect economic growth in the dozen euro nations to rebound from a fourth-quarter slowdown as companies and consumers increase spending, two surveys showed today.

The DIHK chamber of industry and trade raised its forecast for growth in Germany, Europe's largest economy, after a survey of 25,000 companies showed executives plan to increase investment. The Mannheim-based ZEW Center for European Economic Research said its gauge of investor and analyst expectations held near a two-year high in February...

The ZEW Institute's gauge of investor confidence was at 69.8 in February, close to the two-year high of 71 reached in January...

The DIHK lifted its 2006 German growth forecast to 2 percent from 1.5 percent, saying executives plan to increase investment and export growth will fuel higher consumption.

China's trade surplus and Japan's current account surplus grow, UK leading index unchanged

While the US trade deficit grows, the Chinese trade surplus is moving in the opposite direction.

China's trade surplus rose 46.7 percent in January year-on-year to 9.49 billion dollars.

Imports for the month totalled 55.5 billion dollars, up 25.4 percent, while exports rose 28.1 percent to 64.9 billion dollars, the Ministry of Commerce reported on its website.

Japan's trade surplus is not growing, but its current account surplus is.

Japan's current account surplus expands in December for a fourth straight month, the finance ministry said, as exports rose on the back of strong demand from China and the United States.

The current account surplus grew 8.6 percent from a year earlier to 1.75 trillion yen (US$14.8 billion), beating market expectations for a surplus of about 1.6 trillion yen.

The trade surplus alone fell 16.7 percent in December to 1.06 trillion yen, with imports jumping 30.4 percent to 5.02 trillion yen as exports rose 18.7 percent to 6.08 trillion yen.

This was in a month that saw Japanese industrial production grow a seasonally-adjusted 1.3 percent, according to revised data from the Ministry of Economy, Trade and Industry.

Why are the global trade imbalances so persistent? Stephen Roach of Morgan Stanley and Chris P. Dialynas of PIMCO provide reasons.

Meanwhile, the Conference Board's leading index for the UK was unchanged in December, which "suggests that economic growth should remain slow to moderate in the near term".

However, mixed signals from producer prices means inflation concerns will not dissipate so soon.

The Office for National Statistics said on Monday output prices rose 0.4 percent on the month, taking the annual rate of increase to 2.9 percent from 2.4 percent in December and compared with a forecast of 2.7 percent.

That was the highest since September and mainly reflected dearer petrol and diesel following sharp price rises in crude oil...

Output price inflation excluding the volatile items food, drink, tobacco and petrol products fell to 1.6 percent from 1.7 percent in December.

But that was countered by a bigger than expected rise in factories' raw material costs.

Input prices rose by 1.8 percent in January on the month and by 15.4 percent on the year. The annual pace was the second fastest since comparable records began in 1991 after a high of 18.3 percent in December.

And UK house prices continue to recover.

House price inflation picked up to 2.9 percent in the year to December 2005, from 2.2 percent in November, the government said on Monday -- further evidence of a gradual recovery in the property market.

Federal Reserve tightening: Make-or-break year?

Last year, eight rate hikes by the Federal Reserve had little impact on long-term bond yields. Contrary to the fears of some economists who warned that the persistently low bond yields were an indication of a weak US economy, recent economic indicators have been relatively robust. However, similar intransigence in long-term bond yields this year is likely to have a less benign implication.

Alan Greenspan's last act as chairman of the Federal Reserve was to hike interest rates on 31 January, when the target federal funds rate was raised to 4.5 percent. It was the fourteenth consecutive Federal Open Market Committee meeting that had concluded with a rate hike, raising the target federal funds rate from 1 percent back in the middle of 2004.

One of the enduring puzzles -- Mr Greenspan calls it a "conundrum" -- of the past year has been the lack of response in longer-term US Treasury yields to this series of rate hikes. The 10-year US Treasury yield is currently around the same levels as it was back when the rate-hike campaign started. Indeed, as of Friday, the yield curve is actually inverted, with the 2-year yielding about ten basis points more than the 10-year.

Although the last FOMC statement was generally regarded to be less hawkish than previous ones, there is widespread belief that the Federal Reserve is still not done with rate hikes. If the Federal Reserve continues to hike rates while the 10-year yield stays around current levels, the yield curve could invert significantly. That, if history is any guide, signals a recession.

However, in my opinion, the 10-year yield is not likely to stay unmoved by further rate hikes. One of the reasons that it has responded little to the rate hikes so far is that at the time the Federal Reserve started its campaign, the spread between the 10-year yield and the federal funds rate was well over 300 basis points and did not drop below 100 basis points -- approximately its average for the past 50 years -- until around the middle of 2005. Such large spreads encouraged traders and investors to sell shorter-term maturities in favour of longer-term ones, thus keeping the yields for the latter down.

Since the spread dropped to around 100 basis points in mid-2005 -- with the federal funds rate at 3 percent and the 10-year yield at around 4 percent -- both rates have been on an uptrend, although with the latter more moderately so than the former.

The extent that the spread moderates changes in the 10-year yield in response to changes in the federal funds rate can be seen in the following chart.


The chart shows how, over each of the 50 years from 1955 to 2004, the change in the 10-year Treasury yield (shown on the vertical axis) has varied with the difference between the change in the federal funds rate and the spread at the beginning of each year (shown on the horizontal axis). It basically shows that a large spread mitigates the effects of hikes in the federal funds rate on the 10-year yield.

Over the course of 2005, the target federal funds rate was raised by 200 basis points. However, this amount was approximately where the spread stood at the beginning of the year. Fixed income investors looking for yield were never likely to be very impressed.

So the result of all those rate hikes in 2005 was just a small rise in the 10-year yield -- represented by the red square on the chart -- bang in line with what the average historical behaviour predicts.

Clearly, the gradual pace of rate hikes by the Federal Reserve in the presence of a wide spread has much to do with the lack of reaction in the 10-year yield.

However, with the spread now almost gone, further hikes in the federal funds rate are likely to elicit a greater response in the 10-year yield. If it does not, then we all know what that probably means.

This looks like the year that the Federal Reserve's tightening campaign finally breaks either the 10-year Treasury or the economy.

US, French trade deficits hit record levels in 2005, growth outlooks still positive

The US trade deficit hit a record last year. From Reuters:

The U.S. trade deficit skyrocketed in 2005 to a record $725.8 billion, as American companies and consumers snapped up record levels of low-priced goods from China and high-priced oil from the Middle East, a U.S. government report on Friday showed.

The trade deficit, which has risen more or less steadily since 1991 when it was $30.7 billion, widened 17.5 percent in 2005 to set a record for the fourth year in a row.

December contributed to the record.

The December deficit totaled $65.7 billion, up 1.5 percent from a revised $64.7 billion in November, and in line with expectations before the report.

Both U.S. imports and exports set records in December in a sign of a strong consumer demand at home and improving growth in overseas markets that have lagged behind the United States.

U.S. exports increased 2.1 percent in December to $111.5 billion, led by record levels of capital goods, auto and auto parts and consumer goods.

Imports rose 1.9 percent to $177.2 billion with records in several categories, including capital goods, auto and auto parts and food, beverages and animal feed.

But economists expect the US economy to grow at a respectable pace in 2006.

Panelists surveyed in the Blue Chip Economic Indicators newsletter bumped up their projection for annualized gross domestic product growth in the first quarter to 4.1 percent from a prediction of 3.6 percent a month ago. That was well above the fourth quarter's anemic 1.1 percent growth pace.

The panelists cut their outlook for 2006 growth to 3.3 percent from 3.4 percent in January, predicting weaker growth in business spending than they expected a month ago.

Another country that has problems with recent GDP growth and trade deficits is France. From FT:

France’s economy slowed sharply in the final quarter of 2005, creating fresh doubts about the strength of the eurozone’s economic recovery.

Falling industrial production and sluggish consumer spending meant French gross domestic product was just 0.2 per cent higher than the previous three months, according to official data, well below government and economists’ forecasts. In the third quarter of last year, GDP had risen 0.7 per cent.

... Economists estimated that consumer spending...grew by just 0.3 per cent in the fourth quarter, against 0.7 per cent in the third quarter.

Thierry Breton, finance minister, blamed technical stoppages in the automobile sector for much of the 0.3 per cent drop in industrial production in the fourth quarter. Stressing that the estimates could still be revised upwards, Mr Breton stuck to his forecast of 2 to 2.5 per cent growth this year...

But in other grim news for France’s economy, its trade deficit hit a record €26.4bn last year, as high oil prices increased the cost of imported energy and buoyant consumers bought more imported products, offsetting an increase in exports.

Japan does not have problems with trade deficits, but it does have uneven growth in consumer spending. From Forbes/AFX:

Household spending in December averaged 346,230 yen, up 0.8 pct from a year before, the Ministry of Internal Affairs and Communications said.

However, household spending in December fell a seasonally adjusted 0.7 pct from November, declining for the fourth consecutive month.

There is more positive news in other parts of the Japanese economy. From Bloomberg:

Private machinery orders, excluding shipping and utilities, rose a seasonally adjusted 6.8 percent in December, the third straight month of gains, the Cabinet Office said today in Tokyo...

Orders rose 4.1 percent in the three months ended Dec. 31, the government said, predicting they may rise 1.3 percent in the first three months of this year, the sixth quarter of growth.

Meanwhile, the OECD sees continued growth in the OECD countries.

Moderate expansion lies ahead in the OECD area according to the latest composite leading indicators (CLIs). December data show improved or accelerating performance in the CLI's six month rate of change in each of the major seven economies with the most positive signals in Canada and the United States.

South Korea raises interest rates, others may follow

South Korea's Bank of Korea raised its benchmark interest rate by a quarter percentage point to 4 percent yesterday -- a three-year high. Other central banks, however, left monetary policy unchanged.

The Bank of England kept interest rates unchanged at 4.5 percent yesterday, the same day that the Office for National Statistics reported a deterioration in the UK's goods trade deficit to 6.1 billion pounds in December from 6.0 billion in November.

Meanwhile, quantitative easing continued in Japan, but the end of that policy may be near:

Bank of Japan Governor Toshihiko Fukui said core consumer prices will show clear gains in January and after, signaling the bank is getting closer to ending its policy of pumping cash into the economy and holding rates near zero.

Producer prices in Japan clearly have been showing gains.

Japan's producer prices rose at the fastest pace in almost 16 years last month as fuel and metal costs increased and a weaker yen raised the price of imported goods.

An index of prices that companies pay for energy and raw materials gained 2.7 percent from a year earlier, the Bank of Japan said in Tokyo today. The was higher than the median 2.6 percent rise projected by 31 economists surveyed by Bloomberg. Producer prices have risen for 23 straight months.

And the recovery in consumer demand appears likely to be maintained.

Consumer confidence among households with two or more people rose to 49.5 in January, the highest since June 1990, from 46.5 in December, the Cabinet Office said today in Tokyo.

There have also been recent indications that monetary policy may see further tightening in the US.

U.S. interest rates are at a neutral level, but further increases -- even preemptive ones -- may be needed depending on how inflation develops, Chicago Federal Reserve Bank President Michael Moskow said on Thursday.

"Even with the funds rate in the range of neutral, further changes in policy may be appropriate," Moskow said in a speech to the Risk Management Association, echoing similar comments made in January...

On Wednesday, fixed-income markets were rocked by reports that the newly-retired Greenspan had told investment bankers at a private meeting that the market was underestimating potential for higher rates.

And from the latest economic data:

The Labor Department said on Thursday the number of U.S. workers making new claims for state unemployment benefits rose 4,000 to 277,000 in the week ended February 4. Wall Street analysts had forecast a larger increase to 285,000...

It was the fifth week in the last six that claims were below 300,000. As a rule of thumb, some analysts say 350,000 is a threshold signaling a stable market and being consistently beneath this level a sign of strength...

The four-week moving average of initial claims, which smooths weekly volatility to yield a more reliable indication of underlying trends, declined by 7,750 to 276,500, its lowest level since April 2000...

In other data, the Commerce Department said wholesale inventories rose 1.0 percent in December, above expectations, as car stocks climbed and inventories of non-durable goods posted the largest monthly gain in nearly five years.

Wall Street had forecast a 0.4 percent increase in wholesale inventories. The inventories-to-sales ratio, which measures how quickly stocks would be depleted at the current sales pace, was unchanged at 1.15 months' worth in December, a historically lean level.

Japan's bank lending stops declining, UK manufacturing output and German exports grow

Yesterday's economic reports were relatively positive.

Japan's bank lending stopped declining in January. From Bloomberg:

Outstanding loans were unchanged from the year earlier, the first time the value hasn't dropped since December 1997, the Bank of Japan said in Tokyo today...

M2 plus CDs, the main measure of money supply that tracks bank savings, cash in circulation and certificates of deposit, rose 1.9 percent in January from a year earlier, the bank said in a separate report released today.

There were also other positive indicators on the Japanese economy.

The Economy Watchers outlook index, which measures people's economic expectations for the next two to three months, rose to 56.4 points in January, the highest since the survey began in 2000.

In the UK, manufacturing output grew in December, Reuters reports:

The Office for National Statistics said that manufacturing output also beat expectations in December, rising 0.3 percent after an upwardly revised 0.5 percent increase in November and versus analysts' expectations of a 0.2 percent rise. But it fell on a year earlier and over 2005 as a whole...

The wider industrial sector -- which includes Britain's North Sea oil fields -- also posted the second monthly rise in a row, up 0.2 percent versus forecasts of a 0.3 percent rise.

And in Germany, a rise in December helped exports hit a record in 2005, according to Bloomberg.

German exports rose in December to lift last year's foreign sales to a record, led by demand from Asia.

Sales abroad, adjusted for working days and seasonal changes, rose 0.8 percent from November, when they dropped 1.6 percent, the Federal Statistics Office in Wiesbaden said today in a faxed statement. Economists expected an increase of 1.6 percent, the median of 11 forecasts in a Bloomberg survey showed. In 2005, exports rose 7.5 percent to a record 786 billion euros...

Germany's trade surplus narrowed to 9.2 billion euros in December from 13.3 billion euros in November, the statistics office said. In 2005, the surplus widened to 160 billion euros from 156 billion euros in 2004...

Imports rose 8.7 percent last year... Imports rose 5.8 percent in December.

US consumer credit up in December, signs of slowing elsewhere

US consumer credit rose in December, reports Reuters.

U.S. consumer credit rose by a less-than-expected $3.35 billion in December as credit card debt dipped, while consumer credit for the full year posted the smallest rise since 1992, a Federal Reserve report showed on Tuesday.

How consumer credit growth holds up will be important for consumer spending, especially with the housing market expected to slow in 2006.

U.S. home sales will drop in 2006 as mortgage rates climb and house prices inch up at rates far below those notched last year, a trade group said on Tuesday, noting the long-awaited housing slowdown has begun.

The outlook from the National Association of Realtors came shortly after luxury home builder Toll Brothers Inc., widely seen as a bellwether for the housing market, slashed its sales forecast for the second time in three months.

It is conceivable that the US will follow in the footsteps of the UK economy.

Like-for-like sales rose for the third month running in January, the British Retail Consortium said on Tuesday as it predicted tough trading conditions ahead.

The lobby group said sales rose a meagre 0.2 percent in January on the year. That followed a 2.6 percent annual rise in December and marked the worst start of the year since the survey began more than a decade ago.

The New Economist highlights other bad news for the UK economy, including falls in new car sales and manufacturing orders.

And weakness in manufacturing is not limited to the UK. Following the previous day's report that manufacturing orders in Germany fell for the first time in four months in December, yesterday we had news that industrial production in the country also fell in December. Bloomberg reports:

Output slipped a seasonally adjusted 0.5 percent from November, when it declined 0.4 percent, Germany's Economy and Technology Ministry said in a faxed statement today...

Production of capital goods such as machinery dropped 2.4 percent in December from the previous month, today's report showed. Consumer goods output fell 0.2 percent and production of manufacturing and mining slipped 0.8 percent in the month.

Japan's leading index and Canada's PMI up but Europe's retail sales and German factory orders down

The economic data yesterday were mixed.

Japan saw continued improvement in its leading index in December. From Bloomberg:

Japan's broadest measure of future economic activity...climbed to 80 percent from a revised 54.5 percent in November, according to a Cabinet Office report in Tokyo today, matching the median forecast of 20 economists in a Bloomberg News survey. It was the third straight month the index was above 50 percent...

Meanwhile, Reuters reports a rebound in Canadian purchasing activity in January.

The Ivey Purchasing Managers Index...rose to 54.1 in January from 48.3 in December... The result was slightly ahead of market expectations of a reading just above 53, but was still one of the weakest monthly readings of the past year.

But there was negative news from Europe. From Bloomberg:

European retail sales dropped in January for the first time in four months amid rising fuel costs and concern about job cuts, the Bloomberg purchasing managers' index showed.

A seasonally adjusted index of sales in the dozen nations sharing the euro fell to 49.7 from 52.2 in December, led by France, according to a survey for Bloomberg LP by NTC Research Ltd. A reading below 50 signals a decline. Sales fell from a year earlier for a 21st month...

Manufacturing orders in Germany, Europe's largest economy, fell for the first time in four months in December, led by a drop in demand from abroad, a report showed today. Orders declined 1.6 percent from November, when they gained 1.3 percent, the government said.

Meanwhile, in the US, suggestions by BusinessWeek that the economy is stronger than you think got short shrift from Brad Setser and Barry Ritholtz from two different perspectives.

Economic data in US and Europe point to higher interest rates

The latest US employment numbers confirm the previous day's that the labour market is getting tight. Reuters reports:

The U.S. unemployment rate fell to its lowest level in 4-1/2 years in January as employers hired 193,000 new workers, the government said on Friday in a report revising up job growth for the preceding five months.

The jobless rate dropped to 4.7 percent from 4.9 percent in December, the Labor Department said...

Average hourly earnings rose to $16.41 in January from $16.34 in December. In the 12 months through January, earnings have risen by 3.3 percent, the largest for any 12-month period in nearly three years, since February 2003...

The Labor Department revised up December job growth to 140,000 from 108,000 reported previously and said 354,000 jobs were created in November instead of 305,000.

The Reuters report also covered other data on the US economy.

The Commerce Department said factory orders rose 1.1 percent in December on strong demand for machinery and costly durable goods. But a service-sector index from the Institute for Supply Management eased to 56.8 in January from 61 in December, implying slower growth in businesses like restaurants and hotels.

A third piece of data, the University of Michigan's final January index of consumer sentiment, showed confidence flagged in January as high oil prices and a slowdown in overall economic activity in the final months of 2005 took a toll.

Overall, the data set off more fears of higher interest rates.

The prospect of stiffer borrowing costs drove stock prices down. The Dow Jones Industrial Average dropped 58.36 points to end at 10,793.62 and the high tech-laden Nasdaq composite index shed 18.99 points to close at 2,262.58.

But the bond market took the data calmly.

In late trading, the 30-year bond was up 1-1/32 points to yield 4.63 percent, down from 4.70 percent on Thursday.

Europe's economy is also showing signs of heating up, according to this Bloomberg report:

An index of purchasing managers in industries such as airlines and banks in the dozen nations sharing the euro rose to 57 from 56.8 in December, according to a report today by NTC Research Plc for Royal Bank of Scotland Group Plc...

In the euro region, demand for loans to businesses rose "remarkably" in the fourth quarter of 2005, the ECB reported in a survey of bank lending.

The net percentage of banks reporting growing demand for loans rose to 23 percent in the quarter from 17 percent in the third, the Frankfurt-based bank said. Loans for investment, inventories and working capital led the gains...

In the U.K., services expanded for a 34th month. An index of business activity measured 57, down from 57.9 in December, the Chartered Institute of Purchasing & Supply and the Royal Bank of Scotland said today...

Consumer prices rose 2.4 percent in January from a year earlier, the first acceleration in prices in four months, partly because of higher energy costs, a report said today. Crude oil rose more than 11 percent in the month and is up about 39 percent in the past year.

Volume of retail trade had also continued to grow in December.

In December 2005, compared to December 2004, the volume of retail trade grew by 0.8% in the euro-zone and by 2.3% in the EU25. Compared to November 2005, the retail sales index rose by 0.1% in the euro-zone and 0.4% in the EU25.

The data is getting hard to ignore. The Bloomberg report mentioned that on Thursday the European Central Bank left its benchmark interest rate unchanged at 2.25 percent, but that ECB President Jean Claude Trichet also said that bets on an interest-rate increase as soon as next month are "reasonable".

Presumably, the rest of Europe would not be too keen to follow in their UK brethren's footsteps as far as debt is concerned. From Reuters.

The number of people in England and Wales unable to pay their debts jumped an annual 57.1 percent in the fourth quarter of last year to 20,461, the highest quarterly total since comparable records began in 1960, government figures showed...

The number of mortgage repossession orders made in the fourth quarter in England and Wales surged 58 percent on the year, the data showed.

US productivity and jobless claims fall

Two days into his appointment as new Federal Reserve chairman, Ben Bernanke has to contemplate continuing its tightening campaign. Reuters reports the latest US productivity and employment indicators:

The Labor Department said nonfarm business productivity fell at a 0.6 percent annual rate in the fourth quarter, marking the first decline since the first quarter of 2001. That pushed unit labor costs up at a 3.5 percent pace -- the fastest growth in a year and well above market expectations...

New claims for U.S. unemployment benefits fell unexpectedly to 273,000 last week from 284,000 the prior week, pushing a four-week average of claims to the lowest level in nearly six years. Wall Street had expected claims to rise to 295,000.

Investors didn't like the data, as Reuters also reports

U.S. stocks fell sharply on Thursday amid concern that a weaker U.S. productivity report would spur the Federal Reserve to extend its campaign of interest-rate increases...

The Dow Jones industrial average was down 98.69 points, or 0.90 percent, at 10,855.26. The Standard & Poor's 500 Index was down 11.61 points, or 0.91 percent, at 1,270.85. The Nasdaq Composite Index was down 26.92 points, or 1.17 percent, at 2,283.64.

Many investors have assumed that stocks would go up once the Fed stops raising interest rates -- a dubious assumption in itself. But now, they have to confront the possibility that the rate hikes themselves are not quite near an end.

Global manufacturing stays robust in January

The latest indicators from the US show that economic activity remains relatively robust even as the housing market continues to cool. From Reuters:

The Institute for Supply Management said its index of manufacturing activity fell to 54.8 in January, from December's 55.6 reading. The index has stayed above 50, a reading denoting expansion, for about three years...

A separate report from the U.S. Commerce Department showed construction spending rose 1 percent to a seasonally adjusted annual rate of $1.161 trillion from an upwardly revised $1.149 trillion in November...

The Mortgage Bankers Association said U.S. mortgage applications fell for the first time in four weeks last week led by a decline in home purchase loads as interest rates for the first time since November...

In a separate housing report, the National Association of Realtors said its Pending Home Sales Index, based on contracts signed in December, fell to 116.4, down 3 percent from November, and at its lowest since February 2004.

Globally, manufacturing stayed relatively strong as well, with the JPMorgan Global Manufacturing PMI for January reading 54.4, unchanged from December. The euro-zone PMI was 53.5, down slightly from December's 53.6. The UK PMI was 51.7, up from 51.3 in December. China's PMI also edged up to 50.2 from 50.1 in December.

Confidence up in US and Europe, Japan PMI hits record high

There was mixed news for the US consumer yesterday. Reuters reported a rise in consumer confidence.

[T]he Conference Board, a private research group, said its index of consumer confidence rose to 106.3 in January from 103.8 in December, surpassing Wall Street's expectations.

But their wages did not keep up with inflation.

Earlier, the government said U.S. employment costs rose 0.8 percent in the fourth quarter as wage growth picked up and the increase in benefit costs slowed... In the 12 months to December, inflation-adjusted wages were down 0.8 percent, the fifth straight quarterly drop... With inflation taken into account, compensation costs actually shrank 0.3 percent in the last year, the first calendar-year decline since 1996.

Perhaps that is why recent retail sales were mixed.

Redbook Research said sales rose by 4.1 percent on a year-over-year basis for the week ended January 28 as consumers continued to redeem holiday gift-cards. Separately, the International Council of Shopping Centers and UBS Securities said sales slipped in the second pronounced weekly decline in a month.

Manufacturing, though, continues to hold up relatively well.

[T]he National Association of Purchasing Management-Chicago said its business barometer eased to 58.5 in January from 60.8 in December.

Which must be one reason why the Fed raised rates yesterday.

Also on Tuesday, the Federal Open Market Committee raised interest rates at a fourteenth consecutive meeting, putting the fed funds rate at 4.50 percent.

Financial markets suspect another increase from the Fed is likely in March, which would push up interest rates on various loans benchmarked to the fed funds rate.

There was also mixed news on the consumer front in the UK. Consultancy GfK NOP said its barometer of consumer sentiment rose to its highest level in six months in January, but the Confederation of British Industry's distributive trades survey found that retail sales volume fell more than expected in the month, although it is expected to recover next month.

And to add to the contradictory signals, the Bank of England reported yesterday that consumers' unsecured borrowing rose by its smallest amount in five years in December but mortgage lending accelerated more than expected to a 1-1/2 year high. This is after the Nationwide building society reported that house prices jumped by 1.4 percent in January, taking the annual rate of increase to 4.4 percent, its strongest since May 2005.

The mood elsewhere in Europe has also been relatively good recently despite some bad news from Germany. Bloomberg reports:

An index of economic sentiment in the dozen nations sharing the euro rose to 101.8, the highest since June 2001, from December's 100.6, a European Commission survey of more than 110,000 executives and 33,000 consumers showed. Increased confidence among service, manufacturing and construction companies led the improvement, the Brussels-based commission said...

In France, the second-biggest economy, unemployment declined for a seventh month, cutting the jobless rate to the lowest in almost three years, and consumer confidence climbed more than expected, separate government reports showed today...

German retail sales unexpectedly fell for a second month in December, the Federal Statistics Office said today. German unemployment unexpectedly jumped in January for the first month in four as companies brought forward job cuts before a law goes into effect tomorrow that cuts benefits for those newly out of work.

For once, though, Japan gave unambiguously positive signals on its recovery yesterday.

The jobless rate fell to 4.4 percent in December from 4.6 percent the previous month, the internal affairs ministry said, beating economists' forecast of 4.5 percent. For the first time in more than 13 years, the ratio of job offers for job seekers rose to 1.00 in December, meaning 100 jobs are said to be available for 100 job seekers...

In another set of upbeat data, spending by households headed by wage earners in December increased 3.2 percent year on year to an average of 379,769 yen (3,224 dollars), rising for the third straight month.

And Japan's manufacturing PMI hit a record high in January.

January's Nomura/JMMA Purchasing Managers' Index maintained its recent upward trend, rising for a fifth successive month to a level of 57.0, from 55.7 in December. It was the highest reading in the survey history, and represented a marked improvement in operating conditions.