Fed cuts short-term rates

As anticipated, on Tuesday the Federal Reserve Board lowered short-term interest rates by 0.25% to 4.25%. The Fed's action kicked off a busy week for economic reports. On the bright side, November's retail sales soared and industrial production increased, while jobless claims declined. Meanwhile, the U.S. trade deficit rose, business inventories decreased, and two inflation indicators rose steeply because of higher energy prices. For the week, the S&P 500 Index fell 2.5% to 1,468 (for a year-to-date total return of 3.5%). The yield of the 10-year U.S. Treasury note rose 12 basis points, to 4.24%.

FOMC lowered interest rates by a quarter-point

Disappointing those who were hoping for a more aggressive cut, the Federal Reserve Board's Open Market Committee (FOMC) voted to lower the target for the federal funds rate by 0.25%, to 4.25%. Tuesday's action followed rate cuts of 0.50% in September and 0.25% in October. In the accompanying statement, the FOMC cited slowing economic growth caused mainly by the housing downturn and "some softening in business and consumer spending." On Wednesday the Fed unveiled a plan to inject cash into the markets through the auction of short-term funds and open foreign-exchange swaps with central banks in Europe, Canada, Great Britain, and Switzerland.

U.S. trade deficit increased

The Commerce Department's Bureau of Economic Analysis reported that the U.S. trade deficit increased by 1.2% in October to $57.8 billion, above consensus expectations and $0.7 billion more than September's revised deficit of $57.1 billion. Both exports and imports increased for the month, though imports increased more than exports largely because of the increase in crude oil prices. The deficit with China grew to $25.9 billion. Compared with last year, however, the trade deficit declined by 1%; exports rose by 13.7%, while imports rose by 9.2%.

Retail sales soared

In November, retail sales jumped by 1.2%, a sharp increase over October's figure of 0.2%. Though automobile sales decreased, nonauto sales expanded by 1.8%. With November's higher price for crude oil, sales at gasoline stations led growth. Still, despite higher energy prices and the drag from housing, consumers continued to spend, particularly on clothing, electronics, and appliances.

Producer Price Index (PPI) was up sharply

Wholesale prices jumped 3.2% in November, the second-highest increase since this data was first reported in 1947. The increase was driven almost exclusively by a 14.1% surge in energy prices; excluding food and energy, producer prices for finished goods rose by just 0.4%. Increases in the prices of passenger cars and light trucks also helped to boost the core PPI.

Business inventories were below expectations

Modest gains in both manufacturing and the wholesale sector contributed to the decline in October's business inventories. With an increase of 0.1%, business inventories came in below expectations. Retail inventories were up 0.4% for the month. Through the first half of the year, retail inventory gains averaged about 0.2% per month, compared with the current 0.5% pace, an indication that consumer spending may be slowing.

Jobless claims were down

Initial jobless claims dropped for the week ended December 8 by 7,000 to 333,000, from the previous week's upwardly revised figure of 340,000. Still, it is clear from the four-week moving average that claims have grown over the fourth quarter, starting at 310,000 and now averaging appreciably higher. The trend points to an increase in layoffs, consistent with the anticipated economic slowdown.

Higher energy prices drove up the CPI

With its largest increase in two years, the Consumer Price Index (CPI) jumped 0.8% in November on a seasonally adjusted basis, on the heels of a 0.3% increase in October. The main culprit was higher energy prices, which have risen an annualized 34% over the past three months. The core index, which excludes food and energy, increased only 0.3% in November. Over the past year core CPI inflation has been running at a 2.3% pace.

Industrial production rose

Beating expectations, industrial production rose 0.3% in November, following a downwardly revised 0.6% decline in October. Manufacturing output rebounded, rising 0.4%; mining output rose 1.1%; and capacity utilization rose to 81.5% from a downwardly revised 81.4%. Business equipment production also rebounded.

The economic week ahead

Though a relatively light one for economic reports, next week will provide key data on the health of the domestic economy, with the Commerce Department's Thursday report on the nation's third-quarter gross domestic product (GDP), and its report on personal income on Friday. The Conference Board will provide an update on leading economic indicators, also on Thursday. Tuesday's report on new residential construction and Thursday's data on initial jobless claims will fill out the week.