Spotlight on Oil

MBA (7/21/2008 ) Velz, Orawin
Oil and other energy prices played a major role last week. The June Consumer Price Index surged 1.1 percent, posting a year-over-year gain of 4.9 percent, the biggest since May 1991.
The Producer Price Index jumped 1.8 percent in June from the previous month and 9.1 percent from last June, the largest year-over-year gain since June 1981. Energy prices were the main culprit for both strong retail and wholesale headline inflation.

The effect of rising energy prices was also evident in June retail sales, which rose only 0.1 percent, despite a 4.6 percent jump in sales at gasoline stations as gas prices soared. For the second quarter, retail sales grew 2.6 percent, the slowest quarterly pace since the fourth quarter of 2002. The published retail sales data from the Commerce Department are adjusted for seasonal factors but not for inflation. Using the goods component of the CPI to adjust for inflation, retail sales declined in the second quarter.

A separate report last week from the Bureau of the Labor Statistics showed that incomes are not keeping up with prices. Inflation-adjusted average weekly earnings fell 0.9 percent in June from May and were down 2.4 percent from last June. Manufactures also reported sharp increases in the prices they paid for inputs, according to the Philadelphia Federal Reserve manufacturing survey, which showed that the price-paid index rose to its highest level since 1980.

On Wednesday, the Fed released the minutes from the Federal Open Market Committee (FOMC) meeting on June 24-25, which showed that some members believed that downside risks to growth had diminished while the upside risks to inflation had increased. These members argued that a rate hike “would be appropriate very soon.”

In his semiannual Monetary Policy Report to Congress on Tuesday and Wednesday, Fed Chairman Ben Bernanke confirmed the inflation view in the FOMC minutes, noting that upside inflation risks have “intensified,” given elevated energy and commodity prices and the declining dollar. Bernanke was especially concerned that potential pickup in inflation expectations may lead to wage increases during the “wage- and price-setting process.”

However, Bernanke did not reiterate the view in the FOMC statement that downside risks to growth have diminished. Instead, he argued that there are “significant” downside risks to growth outlook, due to the possibility of higher energy prices, tighter credit market and a deeper housing decline.

Good news for the week was the sharp drop in crude oil futures: about $16 in three days, bringing the price below $130 a barrel on Thursday for the first time in more than a month. Crude rebounded slightly on Friday, hovering around $130 a barrel. Declining crude prices spurred some hopes that headline inflation will moderate in the coming months, making it easier for the Fed to keep interest rates on hold for some time. Fed funds futures showed about a 40 percent chance of a 25 basis-point increase in the target rate in September.

Finally, housing news continued to be downbeat. Single-family housing starts declined in June to the lowest level since January 1991. The surge in multifamily starts reflected a rush to start building activity before more stringent local building code changes took effect in New York. Home builders were more pessimistic in July in the face of weakening job markets, rising energy prices and declining home prices, according to the National Association of Home Builders/Wells Fargo Housing Market Index, which declined to a record low in the 22-year history of the survey.

Stock markets rose and lifted major averages from bear market territory, driven by gains on financial stocks including Wells Fargo, JPMorgan Chase & Co. and Citigroup, which released better-than-expect financial reports. In addition, declining crude oil futures extended the equity market rallies. Treasury prices declined and yields rose as investors’ risk appetite increased, making the safety of government bonds less attractive. The yield on the 10-year Treasury note stayed around 4.06 percent by mid-Friday afternoon, 10 basis points higher than the rate on the previous Friday and the highest rate in three weeks.