The Day Ahead: Producer Level Inflation, Retail Sales, FOMC Statement

Benchmark interest rates are higher while equity futures are mixed Tuesday morning ahead of key retail sales data and the afternoon policy statement from the Federal Reserve.

Seventy minutes before the opening bell, S&P futures are 0.50 points higher at 1,236.75 and Dow futures are up 4 points lower at 11,433. The 10 year Treasury note is -13/32 at 94-03 yielding 3.327%. The 2s/10s curve is 3bps steeper at 272bps wide. The FNCL 4.5 is -2/32 at 102-05.

“Since the November 3rd announcement, 7- and 10-year Treasury yields have backed up 60 to 80 basis points,” note economists at BMO Capital Markets, anticipating the Fed policy statement later today. “Given that the policy was put in place to lower real yields, presumably by lowering nominal yields and raising inflation expectations, this aspect of the initial phase of this program has not been a success. Perhaps the emphasis will shift from lowering yields to keeping them as low as they possibly can. We’ll see.”

Key Events Today:

8:30 ― The Producer Price Index, which at last glance was more subdued than expected, is anticipated to rise 0.6% in November, following a 0.4% gain in October ― or half what economists were expecting. A 0.6% increase would leave prices up 3.3% compared to 12 months ago. Core prices, which exclude volatile food and energy costs, are expected to be up 0.2% in the month, after falling 0.6% in the prior month. For the year, core prices should be up 1.2%.

“Both food and energy prices look to have increased meaningfully, based on available exchange-traded prices,” said economists at Nomura Global Economics, who attributed the decline in October’s core PPI to vehicle prices on the annual auto year-end turnover. 

“This price decline is virtually certain not to be repeated, and the main question is whether the vehicle price indexes will settle at new lower levels or whether they will partially recover,” they wrote. “Investigating previous incidents of large October drops in the vehicle indexes, we judge that some payback this month looks likely. Besides this temporary volatility, we believe that core PPI inflation should hold relatively steady as higher input costs offset downward pressure from spare capacity.”

8:30 ― Rising consumer sentiment, Black Friday, and some holiday spirit are expected to boost Retail Sales, the key indicator this week, by 0.6% in November, following a 1.2% leap in October. The October gain was led by auto sales climbing 4.4%. Gains in November are expected to be more broad-based, as auto sales crept up only 0.1% in the month according to the Commerce Dept. The ex-autos figure, which moved up 0.4% last time, is anticipated to be up 0.6%. 

“Retail sales used to estimate consumer spending should be stronger than last year, especially general merchandise, apparel and accessories, furniture and other (GAFO) sales,” said forecasters at IHS Global Insight. “We are holding firm to our view that holiday sales ― November plus December retail sales less autos, less gas, less food services, less nonstore outlets ― will be up 4.5% compared to last year.”

10:00 ― Business Inventories are expected to rise 1% in October. The previous month rose a better-than-expected 0.9% as retailers stocked up more than forecasters assumed. The stock-to-sales ratio was unchanged at 1.27.

“The recent strength in inventory investment has clearly surprised us, and could suggest upside risks to our Q4 GDP growth forecasts,” said analysts at Nomura. “However, some of the gain looks to be related to price effects, rather than increases in real volumes.”

2:00 ― The FOMC Meeting always garners plenty of attention. This meeting will be no exception as analysts will want to see if the Fed’s language changes in light of heavy criticism recently regarding its reflationary program of quantitative easing. Also, the unemployment jumped to 9.8% in November, which should prompt the Fed to defend their monetary expansion policies. The overnight lending rate is not expected to be changed from the current range of zero to 0.25%.

“The FOMC may start to provide hints that it is prepared to be flexible in terms of the size and timing of the QE2 program, indicating that it could be ramped up or ramped down depending on the performance of the economy and other supporting fiscal policies,” said Fed watchers at IHS Global Insight. “Kansas City Fed Chief Thomas Hoenig will cast another dissenting vote, but that will be his last kick at the can for a couple of years, as he rotates off the FOMC board in early 2011. In 2011, the black sheep mantle will fall either to Plosser from the Philadelphia Fed or Fisher from the Dallas Fed.”