Better than expected third quarter productivity gains and a good report on international trade reflected a more robust period prior to the impact of the summer's credit market troubles - sharply lower consumer sentiment was the more timely and significant economic report in the week just concluded.
Stocks and bonds ended with the S&P 500 Index down 3.7 percent to 1,454, now up just 2.5 percent for the year, and the yield of the 10-year U.S. Treasury note fell 7 basis points to 4.22 percent.
Productivity and Labor Costs: Productivity rose more than expected and labor costs fell, both of these developments coming as a surprise to analysts looking for lower productivity growth and higher unit labor costs. Worker productivity grew at an annualized rate of 4.9 percent in the third quarter following a downwardly revised 2.2 percent gain during the second quarter. This increase is consistent with real third quarter annualized GDP growth of 3.9 percent reported last week.
Unit labor costs fell at an annualized rate of 0.2 percent after increasing by an upwardly revised 2.2 percent in the second quarter. This follows relatively strong wage gains over the last year or so, the year-to-date increase falling from 5.1 percent as reported in the second quarter to 4.3 percent in the third quarter. This decline in wages may be part of a slight softening in the labor market where employers feel less inclined to boost wages amid fears that job cutbacks may be in store due to a weakening economy.
Consumer Credit: The amount of new consumer credit in September came in well below expectations, rising by only $3.7 billion, after an upwardly revised surge of $15.4 billion in August. It is hard to draw any conclusions about this report as it reflects activity during the height of the late-summer credit shock when both consumers and creditors were hesitant to borrow and lend, respectively.
International Trade: The U.S. trade deficit with the rest of the world unexpectedly narrowed in September after many thought that higher oil prices would result in an increase. The trade gap narrowed from a revised $56.8 billion in August to $56.5 billion in September as rising exports more than offset slightly higher imports.
The price of imported crude oil rose from $68.09 in August to $68.51 in September and, due to a slightly lower volume of oil imported, the overall oil trade deficit was about even with the month before at just over $24 billion. This oil price data implies that the worst of the recent crude oil price increases will show up in the October report on international trade.
Import/Export Prices: Both import and export prices rose more than expected in October, the higher cost of oil pushing import prices up 1.8 percent for the month and 9.6 percent higher on a year-over-year basis. Note that the report on international trade directly above lags most other economic reports by one month - this can result in a good deal of confusion as import prices for petroleum products rose 6.9 percent in October while they were almost flat in the September trade report.
Export prices rose 0.9 percent for a year-over-year increase of 5.6 percent, this increase driven largely by higher prices for agricultural products that rose 3.9 percent in October. Prices for agricultural exports have risen 29.6 percent on a year-over-year basis.
Consumer Sentiment: The housing and credit market turmoil and sharply rising energy prices are beginning to affect the mood of the American consumer as the Reuters/University of Michigan consumer sentiment index fell to lows not seen since Hurricane Katrina in 2005. In the preliminary report on consumer sentiment for October, the index plunged to 75.0 after a reading of 80.9 in September. The final index for November will be released in two weeks.
In the last 15 years, the current conditions index has been lower only one time - just prior to the invasion of Iraq in 2003. The consumer expectations index fell from 70.1 in October to 64.7 in November - also the lowest level since Hurricane Katrina. The outlook for "inflation expectations" worsened as the one-year expectations level jumped from 3.1 percent to 3.4 percent with the bulk of gasoline price increases yet to come.
It remains to be seen how much the souring consumer outlook will affect consumption in the months ahead. Surprisingly, consumer confidence from the Conference Board and consumer sentiment from the University of Michigan are only tenuously connected to retail sales and personal spending.
Summary: While higher productivity and stable labor costs were good news, they are also very old news reflecting activity in the third quarter prior to the effects of the credit market crisis spreading to the broader economy and relaxed monetary policy spurring higher commodity prices. The surprise narrowing of the trade deficit was also good news, but this report too reflects activity from months ago.
While the ISM services index did show an encouraging improvement, the report with the "freshest" data was the consumer sentiment index released on Friday, a report that probably provides the most accurate indication of where the economy is headed almost three months since the credit turmoil began in August. Fading consumer confidence, with another month or two of rising prices at the pump yet to come, may result in lower retail sales during a critical time of the year, but this is anything but guaranteed - the American consumer has been counted out many times before. Next week's report on retail sales will be greatly anticipated.
The Week Ahead: The week ahead will be highlighted by reports on retail sales on Wednesday and consumer prices on Thursday. Also scheduled for release are pending home sales on Monday, producer prices on Wednesday, two regional manufacturing reports on Thursday, and both international capital flows and industrial production on Friday.