Japan
Succor from Energy Pullback May Not Last Long
July 29, 2008

By Takehiro Sato | Tokyo

Is a Summer Rally Sustainable?

While our emerging economics team has lowered its outlook for next year, there are signs that the bearishness prevailing till mid-July is no longer universal, and our global equity strategy team is now calling for a summer rally.

The economics team’s earlier view on emerging economies looked optimistic, and we have no issue with the downgraded outlook. The buy call from our strategists represents a trading recommendation rather than conversion to a secular bull, and again, we are comfortable with this position. The strategy call for a temporary rebound is founded on respite for a time in the US, with results coming out in the financial industry and indications that the GSE problem has moved beyond the worst, allied to improved prospects for prices to settle down next year, as energy quotes correct, and emerging undervaluation in the stock market.

Just at the point where soaring energy quotes appeared certain to lead to a global recession, welcome relief has come to hand with a pullback in energy. As our European strategists highlight, a near-term rebound for equities of 10-15% would not be a surprise now. Yet, it is clear that beyond this rebound lies further challenges, and for this reason, we cannot get carried away. Even if the stock market becomes a trading buy, being positioned for an early exit in no more than one or two months’ time would be advisable.

Japan-Style Debt Deflation in the US?

So what lies beyond the rebound? My personal view here is that moving past the summer, the US economy could move into a downward spiral, as credit contracts further (and our team’s official forecast calls for two straight quarters of negative growth in October-December and January-March next year, meaning a recession). The writing is already on the wall. For example, the ratio of distressed companies in the corporate bond market (those with credit spreads that exceed 1,000bp) has risen rapidly since 2H07 and now stands around 20%. A spike in this ratio has historically spelled an increase in defaults 6-12 months down the line, implying the risk of more credit events in the coming months. Conditions for fundraising via direct financing such as commercial paper are already tight, and companies are reliant on commitment lines from banks to access liquidity. US commercial banks would start reducing these lines if there is a rash of defaults, likely affecting credit in the non-financial sector, which so far has remained in relatively good shape.

The household sector has also seen home equity lines of credit (HELOC) reined in since the start of the year, as housing prices slump and households are reacting by taking out more credit as a defensive measure. This increased use of credit, along with the recent tax breaks, has apparently allowed personal consumption in the US to hold up better than expected in 1H08, but as commitment lines shrink, the household sector – just like the corporate sector – faces the risk of credit being choked off. That would trigger entrenchment in the US economy, as both corporations and households wait for the storm to pass, and in an extreme case could spark the onset of a Japan-style debt deflation as falling asset prices depress the real economy.

The danger then would not be inflation, but that turmoil in financial markets could feed back into the real economy, causing deflation. Europe and Asia, as well as Japan, would naturally suffer fallout in this eventuality. These regions have their own problems, with Europe facing a clear demand slowdown with the strong euro and collapse of the housing bubble in some countries, and east Asia facing the risk of slower domestic demand due to cuts in energy subsidies and rising prices. Things have moved beyond the point where a modest correction in energy quotes is cause for celebration.

Inflation Set to Stay High in Japan, Even if it Eases Globally

How does inflation look? Inflation rates overseas are more sensitive to primary goods prices than in Japan, and it is generally reasonable to expect inflation to cool as primary goods prices soften. The assumptions in use matter, but this trend is likely to be evident in year-on-year terms. There could also be renewed support for global stock markets if deterioration in corporate margins is halted, as cost-push inflation subsides and scope for looser monetary policy opens up.

However, we see a good chance that near-term inflation in Japan would not peak out even if energy quotes drop back, owing to time lags. Changes in the price of imported energy do affect utility charges, but due to the system, this takes about half a year; similarly, it takes about a year for shifts in the price of imported wheat to affect the government’s resale price or retail prices. This means that the current drop in primary goods quotes will take 6-12 months to feed through to consumer prices, and prices are likely to continue to move higher during the interim. Our CPI simulation, using different energy price assumptions, puts the core CPI for calendar 2009 at +2.1%Y under the current level of futures prices, and this drops only modestly to +1.9% under a price of US$100. For Japan, the prospects for a short-term improvement in cost-push inflation actually look remote. This might suggest that Japan’s stock market has not adequately discounted the risks of further output cuts in manufacturing, as demand falters in the US and Asia and a delay in margin improvement.

Bottom-Up Consensus Is Expecting Too Much

To supplement our comments on the risk of manufacturing production cuts with reference to a simplified case, industrial production during recessions typically contracts by about 6% in the year after peaking. On an annual average basis, the fall is about 3%Y, and assuming no change in selling prices, manufacturers’ sales revenue also falls 3%. In contrast to this simplified case, the current consensus (e.g., in the BoJ’s June Tankan) is, among large manufacturers, for F3/09 sales growth of 3.5%Y. In basic materials industries, forecasts for sales growth assume that selling prices will rise, so it may be too conservative to assume no change in selling prices. Moreover, companies are managing inventory more carefully than ever, so comparison with the average pattern of correction during past recessions may also be misleading. Yet, if sales volumes are indeed set to fall by about 3% on average, we wonder whether it is expecting too much for revenue to rise by more than 3%. Moreover, even the BoJ Tankan targets are looking for recurring profit to fall about 10% on 3.5% growth in sales revenue, and we wonder if this is also too hopeful at a time when sales seem to us to be more likely to fall. Rather, without any noticeable changes in cost structures, the profit outlook gears downwards when sales are likely to fall, and profit drops of even 20-30% would not be all that surprising. Admittedly, non-manufacturing sales fluctuate less sharply than manufacturing, and some industries such as trading, mining and electric power and gas have a relatively high probability of securing revenue on the back of selling price hikes, leading us to expect profit to fall by about 10% at the most for large companies in total. Even this, however, is below the bottom-up consensus. Our conclusion for the Japanese stock market is that we cannot say definitively that valuations are cheap, considering the outlook for a recessionary scenario. This is another reason why we expect the summer rally to be relatively short-lived.

Policy Implications

Stock market sentiment in July has alternated between elation and despair with each development in relation to the GSEs, but these entities are in any case ‘too big to fail’, and it is not surprising that the response since the credit events this March – with debt being protected even if equity is not – is likely to follow the line taken then. At the same time, even though the only realistic option for handling the failure of one US local financial institution may have been to treat them as bankruptcies by giving deposits a haircut rather than transferring operations to the bridge banks, ultimately this may have fanned alarm about the credit situation and undermined US consumer confidence. In addition, given the heavy burden that broader credit tightening going forward may place on the real economy, as noted by our US economics team, we see no reason for the Fed to rush to raise rates. Although there are occasional hawkish comments from regional federal reserve bank governors, these are distinct in nature from orderly information announcements.

In Japan, too, falling energy quotes may quell the rise in prices to some extent, but uncertainty about the economic outlook still restricts the BoJ’s room for maneuver. Although it is true that if deterioration in terms of trade can be halted at the margins, growth in trading losses should also come to a halt and the BoJ’s chief concern should be alleviated, the cumulative damage from the outflow of purchasing power that has occurred up to now is not something that can be repaired easily. However, as energy quotes come down, the source of fresh growth can ultimately be found only in rising productivity, which will require tireless technological innovation by companies and will not happen overnight. We expect this to remain a testing time for the authorities in both Japan and the US, requiring further patience.

Mexico
What Wage Pressure?
July 29, 2008

By Luis Arcentales | New York

With inflation on the rise throughout Latin America and expectations deteriorating, the specter of worrisome spillovers into wages is gaining ground. This is the case in Argentina, where wages have begun to validate rising inflation expectations, thus increasing the risk that inflation will follow suit (see “Argentina: Policy Dilemma Redux”, EM Economist, June 27, 2008). And against a tight labor market and a still-booming economy, manufacturing wages in Brazil rose at a double-digit pace in May, fueling fears that the recent inflation upturn may be morphing into a more problematic wage problem (see “Brazil: A Short Blanket in Tight Labor Markets”, EM Economist, July 18, 2008).

Despite annual headline inflation running at its fastest pace in over three years, wages in Mexico have remained well behaved. Against this backdrop, even as Banco de Mexico hiked rates by 25bp to 8% on July 18, it acknowledged that it had failed to “detect inflationary pressures originating from the demand” side of the economy.   Though July’s hawkish statement left options open for further policy action, given the “worsening in the balance of risks for inflation”, muted wage pressures suggest that Banco de Mexico has some maneuvering room relative to other central banks in the region which, in addition to commodity-driven price pressures, are experiencing signs of labor cost-push inflation as well. 

What Wage Pressure?

The recent upturn in inflation in Mexico has not translated into broad demand for higher wages. Indeed, measures of real wages suggest marginally positive gains so far this year; factoring in productivity growth, wages do not appear to be a source of inflationary pressure. In 1H08, nominal contractual wage hikes have averaged 4.4% (excluding benefits), not materially different from the 4.23% average for all of 2007. Importantly, the relative stability of contractual wages has come in a context of rising headline inflation, which in the first half of July reached 5.37% – the highest annual rate in over three-and-a-half years. While expectations suggest that headline inflation will remain above the central bank’s 4% upper target band until mid-2009, inflation could begin trending lower from current levels as early as next month, thus reducing the risk to wages going forward. 

Whether we look at wage settlements in the public or private sectors, the trend is similarly benign. Private-sector wages rose 4.45% in 1H08, up marginally from 4.34% last year.  Public-sector salaries lagged those in the private sector by rising just 4.18% but, importantly, the adjustments were little different from the 4.08% average for 2007. 

On the surface, May’s outsized 4.70% spike in contractual wages settlements could seem like a warning sign of things to come. However, the details do not validate such concerns. First, May’s pressures did not seem to be generalized as wages in services remained well behaved at 4.3% – in line with the January-April average – while those in industry were pushed higher by outsized moves in mining (5.9%). Second, in the past two years, monthly spikes in wages have coincided with months when only a relatively small number of workers negotiate wages such as May, June and December. Lastly, the most recent June – in which wages rose 4.31% – brought some welcome relief after May’s spike. 

To be fair, not all signs are pointing in the right direction. Last week the workforce of Mexico’s oil monopoly, Pemex, was awarded a 4.8% wage increase, above last year’s level (4.25%) and also the 4.1% from 2006 and 2005. While it could be argued that 4.8% is not necessarily inflationary, Pemex’s is one of a handful of key negotiations – along with those of social security workers and the teachers’ union – that tend to be seen as ‘benchmarks’ for other wage agreements in Mexico. Though slack in labor markets suggests that Pemex’s rising wages need not necessarily lead to economy-wide pressures, last week’s hike likely represents, at the margin, a deterioration of the balance of risks for inflation from the central bank’s standpoint.

Labor Market Slack

The lack of wage pressure in today’s backdrop of rising inflation can be traced back to signs of slack in labor markets. Indeed, evidence from the jobs market – from qualitative surveys to employment figures – seems consistent with Banco de Mexico’s view that the current inflationary episode has not seen demand-side pressures; instead, supply shocks have been largely responsible for pushing inflation higher. This distinction is an important one, as inflation has split the region into two groups of countries. In the first are Brazil, Colombia and Peru, where above-potential growth is adding to global food and energy inflation, with worrisome implications for wage growth. Mexico, by contrast, seems to fall into the second camp, where economic activity is showing signs of sluggishness and wages remain subdued (see “Emerging Inflation?” The Global Monetary Analyst, July 9, 2008).

Mexico’s labor markets are showing signs of deterioration, in line with broader evidence that economic activity is cooling down (see “Mexico: No Immunity”, EM Economist, July 4, 2008). First, newly revised employment data from Mexico’s Social Security Institute (which we use as a proxy for formal employment growth) not only showed that job creation has been lower than the previous data suggested, but also that the pace of the slowdown in job growth seems to have quickened in recent months. In 2Q08, formal jobs grew 2.77% from a year earlier, compared with 3.32% in the previous quarter and a 4.16% rate during 2007. The deterioration is even more pronounced when we try to adjust the calendar for Semana Santa: seasonally adjusted job growth ran at an anemic pace near 1.5% annualized.

The broader jobs survey from Mexico’s statistical institute, INEGI, shows that the rate of unemployment, once seasonally adjusted, rose to its highest levels in over a year. To be fair, the increase in the unemployment rate has been modest, but the upturn comes in a context of an anemic increase (+0.3%) in labor participation, suggesting that part of the jump in joblessness reflects a real underlying deterioration.

Qualitative surveys are also consistent with the presence of slack in labor markets. The central bank conducts a monthly survey in which it asks businesses questions covering inventory levels, confidence, production plans and issues regarding labor. When asked about the difficulty to hire qualified personnel, fewer than 6% of participants in June acknowledged finding higher competition compared to the previous month, whereas 14.1% found a less competitive backdrop. When we net the answers, the trend clearly suggests that in recent months businesses are seeing a less competitive recruiting environment. Additional questions about personnel in production, administration and sales show a similar pattern.

Bottom Line

With headline inflation at its highest level in over three-and-a-half years and likely to remain further from the central bank’s target for longer, it is little surprise to see Banco de Mexico hiking rates. Yet, with growth sluggish at best, the central bank can rightfully argue that the source of the problem has been imported inflation. More importantly, and unlike in Brazil or Argentina, the uptick in inflation has not fed through to an upturn in wages. This should give Banco de Mexico comfort and limit the magnitude of the hiking cycle. The central bank may not be through quite yet, but as long as wages and expectations maintain their current path, we doubt that the central bank will have to embark on a hiking path similar to the one likely still in front of Brazil’s central bank.

United States
Review and Preview
July 29, 2008

By Ted Wieseman | New York

Treasuries ended a quiet week slightly weaker, as better-than-expected economic data Friday, after an otherwise very quiet economic calendar, reversed what had been small gains seen through Thursday when financial stocks resumed sinking after what had been a major rebound off the lows hit July 15.  The durable goods report showed modest upside in both inventories and capital goods shipments relative to our assumptions that led us to slightly raise our 2Q GDP estimate to +2.4% from +2.2%.  The new and existing home sales reports continued to point to stabilization in sales, though recent turmoil in the mortgage market – though the latest week’s performance was much improved from the prior week’s terrible showing – has sharply boosted mortgage rates, creating risks of renewed weakness.  Consumer confidence showed an unusually large upward revision for all of July relative to the early month reading, as the recent moderation in gas prices appears to have had a big impact.  On the negative side, the Richmond Fed manufacturing survey was very weak, further suggesting that the ISM will sink back below the 50-breakeven level, and a spike in initial jobless claims confirmed that the relatively low readings the prior couple weeks just reflected timing problems with the late start to summer auto plant shutdowns.  A very heavy week of supply – US$58 billion total between the 20-year TIPS reopening, 2-year and 5-year auctions – hurt the market through much of the week, but the reasonably solid results for the 2-year and 5-year legs (after a very sloppy start at the 20-year TIPS reopening) helped the market extend a big stock-driven Thursday rally once the auctions were out of the way.  With the giant housing bill that includes the GSE support provisions moving towards likely Senate passage on Saturday, other interest rate markets performed relatively well on the week, with swap spreads coming way in significantly and mortgages and agencies tracking this tightening.  This had a mixed impact on Treasuries at times, but, except at the very short end, was on net probably positive, as some switching out of Treasuries into higher-yielding agencies and mortgages as the housing bill moved towards passage was apparently outweighed by the positive impact of the rallies in these markets and good mortgage duration-related receiving in swaps as the market surged Thursday when financial stocks resumed their slide. 

On the week, benchmark yields rose 3-4bp, with the improved performance of mortgages and swaps helping the belly of the curve marginally outperform.  The old 2-year yield rose 4bp to 2.66%, the old 5-year 3bp to 3.43%, the 10-year 3bp to 4.11% and the 30-year 4bp to 4.70%.  The new 2-year closed the week at 2.714% after being auctioned Wednesday at 2.82% and the new 5-year at 3.447% after being auctioned Thursday at 3.440%.  The very short end took a big hit as investors switched into agency money market paper, with the 4-week bill’s bond equivalent yield up 45bp to 1.72% and the 3-month 26bp to 1.73%.  With September oil falling another US$6 a barrel on the week for a US$22 two-week drop to US$123.26, TIPS had a terrible week.  The front end of the TIPS market was particularly crushed, and major underperformance extended to the intermediate part of the curve, though the long end didn’t do too terribly.  The 5-year TIPS yield spiked 31bp to 1.24%, the 10-year 14bp to 1.78% and the 20-year 10bp to 2.25%.  Since the recent peaks three weeks ago, the benchmark 5-year inflation breakeven has now fallen 51bp and the 10-year 28bp.  Indeed, the 5-year breakeven at 2.21% is a completely reasonable long-term forecast for core CPI inflation, so the market is effectively betting that food and energy will have no additional net impact on inflation over the next five years.  Other interest rate markets performed relatively strongly the past week.  Swap spreads fell significantly, reversing the prior week’s big widening, with the benchmark 5-year spread falling 10bp to 89.25bp and the 10-year 6.5bp to 69.5bp.  After a soft day Friday, current coupon mortgages traded about in line with this swap spread tightening for the week as a whole, a much better showing than the prior week’s nearly full point underperformance that showed up in a major way in mortgage rates being offered borrowers this week.  10-year agencies performed similarly, ending the week flat to Libor, unchanged on the week, also after seeing a bit of cheapening Friday.  The very short end of the agency market, however, richened considerably on the week, amid very strong demand for discount notes.

A volatile week ended up with risk markets mostly not much changed.  The S&P 500 dipped 0.2%.  Within this tepid overall performance, focus of interest rate investors remained largely on financials, which swung wildly.  The huge rally off the July 15 lows extended through Wednesday before a big, partial reversal Thursday and Friday that left them mixed on the week.  The BKX banks stock index rose 1% on the week after an 8% decline Thursday and Friday followed what had been a 41% rally from the 12-year low hit July 15 through Wednesday’s close.  The S&P 500 investment banks sub-index lost 5% on the week after a 9% sell-off Thursday and Friday followed a 26% rally off the 5-year low hit July 15.  The GSEs’ stocks traced a similar trajectory.  Like the broad stock market, credit didn’t do much on the week.  In late trading Friday, the broad investment grade index was 2bp tighter at 135bp, though its HiVol subset was 15bp wider at 360bp.  The high yield index was 1bp wider at 686bp through Thursday, and the index was trading down marginally Friday afternoon.  The subprime ABX market rose a bit on the week, with the AAA index up 0.21 points to 42.34 and the AA 0.69 points to 10.16.  The commercial real estate CMBX market, on the other hand, had a rough week, with the AAA index widening 14bp to 160bp, the AJ 38bp to 492bp, and the AA 43bp to 691bp, their worst levels since March (though still substantially below the wides hit during the mid-March turmoil).  Leveraged loans were a relative outperformer, with the LCDX index 15 tighter on the week at 390bp through midday Friday. 

Aside from slightly increased confidence in an October move, Fed rate-hiking expectations in the futures market were scaled back a bit on the week after a lot of day-to-day volatility.  The October fed funds contract lost 0.5bp to 2.115% and November 1bp to 2.205%, but January gained 2.5bp to 2.305% and February 4bp to 2.445%.  In contrast to the slight Treasury market sell-off, eurodollar futures all posted modest gains on the week.  The best gains of around 8bp were at the long end, though the Mar 09 contract, which rose 5.5bp to 3.245%, and Jun 09, which gained 5bp to 3.47%, put in strong relative performances at the short end. 

Durable goods orders rose 0.8% in June, as a sharp pullback in the volatile aircraft component (-20.3%) only partly offset a good gain in the key core gauge, non-defense capital goods ex-aircraft (+1.4%), upside in defense capital goods (+15.8%), primary metals (+5.1%), and fabricated metals (+1.7%).  Strength in core orders was led by machinery (+2.3%) and electrical equipment and appliances (+5.0%), while high-tech orders (-0.5%) were a bit lower.  Core capital goods shipments (+0.7%) rose for a fourth-straight month, pointing to a good gain in business investment in 2Q.  We see the equipment and software component of business investment rising 7% in 2Q, up a point from our prior estimate.  Recent upside has likely been supported by temporary tax incentives that were part of the fiscal stimulus bill.  Overall durable goods inventories (+0.5%) also came in higher than we assumed, trimming our estimate of the 2Q inventory drag slightly.  Combining the investment and inventory upside, we raised our 2Q GDP forecast slightly to +2.4% from +2.2%.

Home sales continue to show signs that are bottoming out, but mortgage market pressures point to potential downside risks going forward.  New home sales dipped 0.6% in June to a 530,000 unit annual rate.  There were significant upward revisions to prior months that left the June sales pace 3% above the trough hit in March.  Homes available for sale plunged 5.3% in June for a 22% drop over the past year.  Combined with the stable sales pace, this lowered the months’ supply to 10.0 from a downwardly revised 10.4.  While this remains way above a more balanced level of around six months, there has been decent recent improvement since the peak of 11.2 months hit in March.  Even if sales are troughing, we estimate that single-family starts will need to plunge another 20% or so more to bring inventories back towards a more normal level by the first part of next year.  Meanwhile, existing home sales declined 2.6% in June to a 4.89 million unit annual rate, extending a recent run of relative stability that has left sales little changed over the past six months.  The existing home sales inventory situation is worse than new homes.  The number of homes available for sales ticked up 0.2%, which, combined with the decline in the sales pace, pushed months’ supply up to 11.1 months from 10.8, just below the high of 11.2 hit in April.  While these reports continue to point to stabilization in home sales, mortgage market conditions present renewed downside risks.  After the huge underperformance by MBS in the week of July 18 on top of the back-up in Treasury rates, Freddie Mac’s survey showed that the national average 30-year mortgage rate surged to 6.63% in the latest week from 6.26% last week, its highest level in nearly a year.  Hopefully, the better tone in the MBS market the past week and the imminent passage of the housing bill will lead to a quick moderation in rates.

After the quiet past week, the economic calendar is very busy in the coming week, with focus on the initial round of key July data on Friday, the employment report, ISM and motor vehicle sales.  Earlier in the week, Wednesday’s Treasury refunding announcement will be a focus.  We look for a US$2 billion increase in the 10-year to US$17 billion and a US$1 billion increase in the 30-year to US$10 billion.  There has been increasing talk recently about the Treasury possibly announcing a move to monthly 10-year issuance from the current twice a quarter pattern or reviving the on and off 3-year note again.  From a financing perspective, such steps do not appear at all necessary under reasonable budget deficit assumptions (we are forecasting a US$425 billion deficit in F2008 and US$380 billion in F2009), since a tremendous amount of money will be raised by the recently reintroduced 1-year bill over the next year.  At the current size of $19 billion, the Treasury would raise a huge US$157 billion in new money in F2009 from year bills since there will be 13 auctions against only five (two at smaller sizes) in F2008.  We can’t rule out additional 10-year issuance or the return of the 3-year, however, if the Treasury is concerned enough about the risk of significantly greater borrowing needs over the next year and wants to provide additional flexibility in case of a dire financing outcome.  The key economic data releases due out in the coming week are consumer confidence Tuesday, GDP and ECI Thursday, and employment, ISM, construction spending and motor vehicle sales Friday:

* We expect the Conference Board’s measure of consumer confidence to rise to 54.0 in July.  The University of Michigan gauge registered a noticeable uptick in July – with virtually all of the improvement coming during the second half of the month when gasoline prices began to edge lower.  The Conference Board survey is conducted over the course of the entire month but should still capture some of the uptick.  So, we look for a modest gain in the Conference Board measure on the heels of the 16-year low of 50.4 seen in June.

* A sizable positive contribution from foreign trade, together with some impressive resilience in consumer spending and a rebound in capital spending, should lead to a moderate 2.4% gain in 2Q GDP. In fact, were it not for an anticipated 1.1 percentage point subtraction from inventories, economic growth would have been even stronger last quarter. Declining residential construction activity still represents an important headwind – although the pace of the drop-off seen in 2Q should be a bit less than seen in prior quarters. At this point, it’s impossible to gauge the economic impact of the stimulus rebate program with any degree of precision. But, it does appear that more may have been spent – and somewhat sooner – than was anticipated. We suspect that GDP may have been boosted by more than two full percentage points in 2Q. Of course, the payback effect tied to the temporary stimulus should start to become evident in 4Q. On the inflation front, the GDP deflator should moderate to about a 1% pace in 2Q, reflecting the negative impact of a sharp rise in import prices. Finally, note that this report will include the annual benchmark revisions to the past three years of GDP data.

* We expect the employment cost index to rise 0.8% in 2Q.  A build-up of some slack in the labor market appears to be helping to restrain wage inflation.  So, we look for the wage category to continue to drift sideways.  Meanwhile, the benefits component registered a below-trend reading in 1Q, and we look for a reversion to the mean in 2Q.  This all adds up to a +0.8% expected result for the quarter, with the year-on-year rate likely to tick down slightly to +3.1%.  Another hike in the federal minimum wage goes into effect in 3Q, but this is unlikely to have any significant impact on wage inflation since it is still below the rate set by many large states.

* We look for a 50,000 decline in July non-farm payrolls.  The jobless claims data have been quite volatile of late, but the survey week reading came in much lower than we had expected. While a potion of the early July pullback in filings likely reflects seasonal adjustment problems, the same issues could influence the payroll figures.  Indeed, we suspect that a relatively early survey period may provide a bit of a boost (note: July 12 fell on a Saturday, so the survey period this month was as early as is possible).  Moreover, withheld tax collections at the federal government level have held up somewhat better than the payroll employment data would suggest.  By sector, we look for continued sizeable job losses in construction and manufacturing, along with an accelerated pace of decline in financial services.  However, the healthcare category is expected to rebound following a below-trend result in June.  The bottom line is that while we look for jobs to post an outright decline for the seventh consecutive month, the drop-off is not expected to be quite as large as seen during the first half of the year.  Finally, the unemployment rate is likely to resume its upward drift this month, rising to 5.6%.

* We expect the manufacturing ISM to fall to 49.0 in July.  The regional surveys that have been released to this point reveal a mixed picture, with Empire registering an uptick while Philly held steady at a relatively depressed level and Richmond showed modest deterioration.  Still, we look for the ISM to show a pullback on the heels of the surprising jump seen in June.  Also, after registering a post-1970s high of 91.5 in June, the price index is expected to show only a slight decline in July.  However, if the recent pullback in energy prices is sustained, we should see a much more noticeable normalization of the ISM price measure in coming months.

* We forecast a 0.9% decline in June construction spending.  Another sharp fall-off in single-family starts points to a further decline in the residential category.  Meanwhile, we’ve been surprised by the resilience of non-residential construction activity, but signs of a slowdown appeared in May, and we look for a continuation of this trend in June.  Finally, the public component is expected to reverse the slight uptick seen in May.

* We look for motor vehicle sales to rise to a still anemic 14.0 million unit annual rate in July.  High fuel prices continue to weigh on the demand for new vehicles – especially in the truck and SUV sector.  However, a new round of incentive offerings appeared to bring in some buyers toward the end of June, and thus we look for a slight uptick in the sales rate relative to the 13.6 million unit pace seen in June – which represented a 15-year low.  One additional complicating factor this month is that the Commerce Department has not yet released the seasonal factor for July.  According to our contact, the new seasonals will not be released until the morning of August 1, and thus we are likely to have a late update to our forecast.