Capital Markets Analysis

JULY 23, 2010

Industrial Production Edges Up Slightly

Industrial production edged up 0.1 percent in June, marking the fourth straight monthly increase in overall production. Although the increase was relatively soft, it did beat analyst expectations of a 0.2-percent drop for the month. Production during Q2 increased at a 6.6-percent annualized rate, down slightly from Q1’s 7-percent rate.

The small gain for June was concentrated entirely in mining and utilities, where output rose 0.4 percent and 2.7 percent, respectively. The utility output gain, spurred mostly by one of the warmest Junes on record, followed a 5.6-percent jump in May. Manufacturing dropped 0.4 percent for the month, the largest drop this year. Capacity utilization was unchanged at 74.1 percent. Manufacturers have helped lead the economy out of the recession, but continued growth will depend on recovery of the labor market over the next several quarters.

Source: Federal Reserve

Retail Sales Drop

Retail sales fell for a second straight month, indicating consumption is not as strong as many Wall Street analysts had thought. Sales fell 0.5 percent in June following a downwardly revised 1.1-percent drop in May. The decrease was driven by declines at building supply stores, general merchandise stores, auto dealers, gas stations and apparel stores. Motor vehicle and gasoline sales both increased 0.1 percent. On a year-ago basis, retail sales are up 4.8 percent—strong, though still below the level of two years ago.

Consumers are still facing major economic headwinds including weak income and job growth, high levels of debt and a weak housing sector. There is demand for certain consumer goods, and increases in sales earlier in the year provided some hope that consumers were going to be greater contributors to recovery efforts. The consecutive monthly decreases in retail sales indicate that momentum in consumer spending has slowed.

Consumer Prices Fall for Third Month

Consumer prices fell for a third consecutive month due to protracted weakness in energy prices. The Consumer Price Index (CPI) fell 0.1 percent in June following a 0.2-percent decline in May, according to the Bureau of Labor Statistics. The energy price index component of CPI, which fell 2.9 percent in June, has not recorded a positive reading this year except in January. Year over year, consumer prices are up 1.1 percent—a significant drop from May’s level of 2 percent.

Core CPI, which excludes food and energy prices, rose 0.2 percent for the month, the largest pickup in core prices since October 2009. A broad increase in consumer item prices drove June’s increase, although core CPI is up just 1 percent from a year ago, indicating core inflation is well contained. As a result, the Federal Reserve likely will continue to leave short-term interest rates unchanged through at least the first half of 2011, if not longer.

Producer Prices Fall More Than Expected

Producer prices for finished goods dropped 0.5 percent in June, more than the 0.1-percent decline Wall Street economists had been expecting. A 2.2-percent drop in food prices, the largest monthly decline since 2002, was the key driver behind the drop. A modest 0.5-percent decrease in finished energy goods also contributed to the decline in prices. Over the past year, the Producer Price Index (PPI) is up 2.7 percent, a significant drop from May’s year-over-year increase of 5.1 percent.

Excluding food and energy, core PPI was up just 0.1 percent in June, consistent with an environment of well-contained inflation. On a year-over-year basis, core PPI continues to hover around 1 percent—coming in at 1.1 percent in June. The low core inflationary environment reflects low price pressure due to excess spare capacity.

Housing Starts Fall Again

Housing starts fell 5 percent to a seasonally adjusted annual rate of 549,000 in June, the slowest pace in more than a year. Multi-family homes weighed down production with a sharp 21.5-percent drop. Housing starts are down 5.8 percent compared to a year ago, the first recorded year-over-year decline since the second half of last year.

Total building permits increased 2.1 percent from May to 586,000, driven by strong demand for multi-family units. Multi-family housing permits grew 19.6 percent to an annual rate of 165,000 in June, offsetting the 3.4-percent decline in single-family home permits.