The Week Ahead: Treasury Auctions, Inflation Data, Fed Speak, Beige Book

Benchmark interest rates spent the week that was bouncing around a wide yet well-defined range in advance of the highly anticipated release of December's Employment Situation Report.  While it seemed like ADP stole the show on Wednesday after a much stonger than expected report, the official read on the labor market turned out to be bullish for rate watchers. Payroll growth disappointed and although the unemployment rate fell to a 19 month low, an asterisk was needed to explain the cause of that so called improvement. MND explained that asterisk HERE: Two-Headed Labor Market Presents Problem for Bond Investors

An equity sell-off in Europe, prompted by reports that France and Germany are pressuring Portugal to take an EU-IMF bailout to prevent contagion have helped benchmark interest rates hold onto Friday's gains. Gains are however shrinking as the well-defined range runs out of room to rally. THIS POST outlines the range aptly. The 10 year note begins the week +0-03 at 94-08 yielding 3.316%.  Benchmark 10s must break 3.30% resistance and confirm that break with a washing out of short sellers followed by an accumulation of new long positions if mortgage rates are to move any lower from here.

Meanwhile in the equity markets, the second week of the New Year is off to a shaky start  for risk investors as the market continues to digest Friday’s less than impressive nonfarm payrolls report.

“The S&P 500 has been stretched to a point not seen in more than two years, and there are now small but faint signs that investors are starting to take out protection against losses should the market correct,” said Thomson Reuters. “It's been a while since the market has really had a true correction that lasted more than a couple of days but certain ratios and indicators put it as a likely occurrence before long.”

S&P 500 Futures are down 5.25 points to 1,262.25. Dow Futures are down 42 points to 11,577.

No new data hits the market today, but later in the week we’ll see retail sales, two inflation reports, the trade balance, a preliminary consumer sentiment report, and industrial production. No major housing data comes out this week but three Treasury coupon auctions will influence the movement of mortgage rates.

In addition, the fourth quarter earnings season kicks off this week with Alcoa Inc. and Intel Corp. expected to report “markedly higher profits”, according to the Wall Street Journal. The newspaper says overall Q4 profits “are projected to jump 9.8% from a year ago.”

Key Events This Week:

Monday:

12:30 ― Dennis Lockhart, president of the Atlanta Fed, speaks on the US economy to the Rotary Club of Atlanta.

Tuesday:

8:30 ― Charles Plosser, president of the Philadelphia Fed, speaks on the economic outlook to the RMA Philadelphia Chapter meeting.

10:00 ― November’s Wholesale Trade report is anticipated to show inventory and sales growth of 1.5% and 1%, respectively, following gains of 1.9% and 2.2% in the prior month. The gain in inventories is especially significant as the previous month’s rise beat consensus forecasts by a full percentage point and September’s gain was revised up to 2.1% from 1.5%. 

“Given that private inventories contributed 1.6 percentage points of the 2.6 annualized growth in 3Q10, markets will watch closely wholesale inventories,” said economists at BBVA. “Current trends indicate that wholesale inventories continued to increase in November.”

Economists from Nomura note that inventories have expanded at an annualized pace of 22% in the last three months ― the largest three month gain in the history of the series. 

“In our view, most of the recent increase reflects higher prices for the many commodity products passed through wholesalers ― oil, foodstuffs, metals, etc ― rather than an increase in real trade volumes,” they added. “This month we look for another big increase of 1.5% m-o-m.”

1:00 ― Narayana Kocherlakota, president of the Minneapolis Fed, speaks before a luncheon hosted by the Wisconsin Banker's Association.

6:00 ― John Weinberg, research director at the Richmond Fed, speaks on the economic outlook before Frederick County's 7th Annual
Economic Symposium. 

Treasury Auctions:

• 1:00 ― 3-Year Notes

Class A MBS coupons begin the settlement process.

Wednesday:

7:00 ― Higher interest rates continue to pull down loan application volume in the weekly MBA Mortgage Applications Index. The average interest rate for a 30-year fixed-rate mortgage finished the year at 4.82%, an historically low level but relatively high compared to a few months before. 

“In a discouraging sign for the home sales outlook, the nascent recovery in purchase applications has recently stalled,” said economists at Nomura Global Economics, commenting on the 0.8% drop in purchases reported last week. “Unless the improving trend from late November returns, we may need to lower some of our home sales forecasts.”

2:00 ― The Federal Reserve’s Beige Book, an anecdotal look at the economy compiled by each of the central bank’s 12 districts, is expected to report gradual improvement in the economy. The last report, released on December 1, reported that ten districts had seen a modest or a stronger recovery, and just two districts reported mixed conditions. By contrast, the summer was described as showing “widespread signs of deceleration.”

“Given the broad-based pickup in activity over the last two months, we think this Beige Book is likely to sound considerably more upbeat,” said economists at Nomura Global Economics. “This is supported by the recent FOMC minutes, which noted that the Fed's business contacts ‘had become more optimistic about the outlook for sales and production’.

“We expect the report to indicate that the economy gained momentum during the period, and that labor market conditions firmed. It will also be interesting to see if the Fed finds evidence of higher commodity prices passing-through into retail goods prices.”

1:00 ― Richard Fisher, president of the Dallas Fed, speaks on “The Limits of Monetary Policy” before a Manhattan Institute luncheon.

2:00 ― The monthly gap in the Treasury’s Budget Statement for December is expected to be $85 billion, following a deficit of $150 billion one month before. Estimates from the nine economists polled by Reuters range from $85 billion to $165 billion.

“We expect the Treasury to report a budget deficit of $85bn for December, down slightly from last year because of improving tax revenues,” said the forecasting team from Nomura.

Treasury Auctions:

• 1:00 ― 10-Year Notes

Thursday:

8:30 ― The Trade Balance is expected to deteriorate in November to a deficit of $41 billion, versus a gap of $38.7 billion in October. The October deficit was the narrowest since early 2010, as exports jumped 3.2% for a second straight increase, while imports slumped for a second month.

“We expect both exports and imports to move higher, but exports to rise slightly faster,” said economists at IHS Global Insight. “We expect some easing in consumer goods imports after a sharp jump in October. For the fourth quarter, foreign trade is shaping up as a major plus for GDP growth, as export growth has bounced back after a quiet third quarter, while import growth has slowed.”  

8:30 ― Rising oil prices are expected to push the Producer Price Index up 0.8% in December, putting the annual change at +3.8% (up from +3.5%). Core prices, which excludes volatile oil and food costs, are anticipated to rise a slimmer 0.2%, leaving the annual change at +1.4% (up from +1.2%).

“The big shove will come from double-digit gains in gasoline, diesel, and heating oil because of higher crude oil prices,” said economists at IHS Global Insight. “Another climb in food prices won't help, but oil will be the major culprit.”

Economists at Nomura agreed, writing that “finished energy prices in particular look to have increased sharply during the month, but we expect that the food index was about unchanged.” 

They added that an end to auto-related volatility should keep the monthly core index at 0.2%. 

8:30 ― Initial Jobless Claims rose in the final week of 2010 but the four-week still managed to decline to 410,750 ― the lowest since late July 2008. December’s nonfarm payrolls report didn’t meet optimistic expectations based in large part on the falling number of claims, so the market will want to see if the trend is still on a downward course or whether lay-offs slowed down merely due to the holidays. 

Meanwhile, continuing claims ― a tally of all those still receiving regular unemployment benefits ― fell 47k in the week of Dec. 25 to 4.103 million, the second lowest in more than two years.

Estimates were not available for this Thursday’s release.

1:00 ― Ben Bernanke, chairman of the Federal Reserve, participates in a “Framing the Issues” panel before the Federal Deposit Insurance Corp.’s  “Overcoming Obstacles to Small Business Lending” forum. 

Treasury Auctions:

• 1:00 ― 30-Year Bonds

Friday:

8:30 ― As with producer prices, the Consumer Price Index is expected to climb more than in previous months due to rising energy prices. The index inched up 0.1% in November and is expected to rise 0.4% in December, pushing the annual change up to 1.3% from 1.1%. Core prices are set to inch up 0.1%, leaving the annual change stable at 0.8% ― well below the Fed’s unofficial 2% target level.

“The core CPI should only creep 0.1% higher, but a jump of more than 5% in energy prices should push overall consumer prices up 0.6%,” said economists at IHS Global Insight, noting that gasoline prices probably rose 9%. 

“Gasoline pump prices climbed more than 12 cents/gallon, and since prices normally fall in December, the seasonal adjustment process will amplify these gains,” they added. “Core inflation remains quiet, though, as producers are fighting for business and retailers beat each other up for market share.”

Analysts at BMO Capital Markets noted the rise in gasoline prices marked the sharpest jump for any December since 1935.  The fact that December is typically a time when gasoline prices soften means the seasonal factors will actually boost the raw figures, they added. 

8:30 ― The key release this week is the Retail Sales index for December. Economists anticipate a 0.8% rise in the month, equivalent to the November gain which was described as “surging.” The gains are expected to be less broad, however, in part because of rising oil prices.

“When you’re buying new vehicles and filling their tanks with expensive gasoline, you don’t have as much money left over for other things, and it’s much harder to spend what’s left over when you’re waist high in snow,” said economists at BMO Capital Markets. 

Excluding auto sales, the index should rise 0.7%, compared with +1.2% a month before.

“Strong personal consumption, consumer sentiment and expectations point to strong retail sales in December,” said analysts at BBVA, who say retail sales have advanced an average of 1% in the last five months. “Possible improvements in labor markets and new tax cuts are also expected to support retail sales in the coming months.”

Economists at BTMU added that the retail sector continues to battle a high unemployment rate, “but consumer confidence is picking up and government stimulus should help boost jobs and spending in 2011.”

9:15 ― Industrial Production should rise 0.5% in the final month of 2010, a slightly better pace than the 0.4% uptick in November. The November gain was considered “solid” as manufacturing climbed 0.3%, construction jumped 0.9%, and utilities output halted a three-month downward trend and rebounded 1.9%. 
Positive readings in recent manufacturing surveys suggest continued growth in December, particularly with the Chicago Business Barometer clocking in with a 22-year high, according to Deutsche Bank.

“Industrial production should climb 0.7% in December, with a very cold month ― the coldest December since 2000 ― spiking utility output more than 3% higher,” said economists at IHS Global Insight. “The manufacturing sector should have a decent month, too, with some help from motor vehicles, taking overall manufacturing up 0.5%, in line with bullish production reports from the ISM survey.”

9:55 ― Consumer Sentiment is on the rise but continues to be held back from big gains due to high unemployment, rising gasoline prices, and a wrecked housing market. The Reuters / U of Michigan index is forecast at 75.4 in January, just less than a point up from December’s final figure. December’s figure was the highest since June, but remains relatively low with the economic outlook component at just 67.5.

“The Index of Consumer Sentiment edged up to 74.5 in December, but we think it has further to rise,” said economists at Nomura. “Strong stock prices, falling jobless claims and generally improving news about the economy should support household confidence. In addition, the tax compromise agreement reached between the White House and Congressional Republications should lift the ‘Opinions about government policy’ index in the report, which is closely correlated with the total index.”

10:00 ― The week’s final major release, Business Inventories, should rise 0.7% for the second consecutive month in December. Estimates from the 26 economists polled by Reuters range from +0.2% to +1.3%.

On already-reported gain of 0.8% for the manufacturing sector led analysts at Nomura to look for a 1% increase overall.

“Despite this healthy growth, inventories look likely to subtract more than 2 percentage points from Q4 GDP ― because inventory growth will be down from Q3,” they added.

12:00 ― Jeffrey M. Lacker, president of the Richmond Fed, speaks on the economic outlook before the Risk Management Association's Richmond chapter.

1:15 ― Eric Rosengren, president of the Boston Fed, speaks before the New England Mortgage Expo hosted by the Connecticut Mortgage Bankers Association and
The Warren Group.