Brazil
Rate Cuts – Slower for Longer?
May 12, 2009

By Marcelo Carvalho | Sao Paolo

The latest monetary policy minutes send a clearly dovish message. The growth downturn has created plenty of slack in the economy, which is unlikely to be eliminated quickly in an environment of gradual recovery. In turn, slack pulls inflation down, opening room for further rate cuts. Tentative signs of recovery have led the central bank to slow down the pace of easing, but the central bank still has work to do, in our view. Unusually explicit, the monetary policy committee (COPOM) says that the improving inflation outlook has not been incorporated so far in the yield curve. That is, the central bank believes that rates will go lower than markets have priced in. In all, the central bank’s balance-of-risks analysis currently seems to focus on lingering economic slack, which supports further monetary easing ahead.

COPOM Minutes: Dovish

Dovish minutes suggest further easing ahead. When the central bank slowed the pace of rate cutting to 100bp on April 29 (from 150bp in March), a laconic accompanying statement added that the decision was “aimed to extend the monetary easing”. As we suspected, subsequent dovish minutes clarified this: it seems the central bank slowed the pace of easing so that it can cut for longer.

Return of global confidence remains fragile, the minutes argue. The central bank described two main scenarios in the latest quarterly inflation report, as of March. In the first scenario (which the central bank has judged most likely), the global turmoil would last for longer, extending into 2010, and its negative repercussions for Brazil’s economy would persist throughout the forecast horizon. In the second scenario, if the global recovery comes sooner and faster than anticipated, then the recuperation in financial conditions and confidence, besides rising commodity prices, could imply rising inflation risks. The minutes say that there are incipient signs of reduction in global risk-aversion, but this is still subject to reversal – the return of confidence remains fragile, given market sensitivity to the news flow, the minutes argue.

The minutes seem consistent with other recent public policy statements, which sound cautious on growth recovery and improving market sentiment. The central bank has argued that Brazil shows signs of sequential recovery, but warns that this does not mean the turmoil is over. The authorities are on record that it is still premature to worry about post-crisis issues and warn that excessive optimism is dangerous and can lead to disappointment at the first negative data point.

The central bank’s balance-of-risks analysis currently seems to focus on economic slack, or the so-called output gap – that is, the distance between actual growth and potential growth. In the balance-of-risks assessment, the minutes underscore that the growth downturn has opened up slack in resource utilization, which pulls inflation down. On the other hand, potential currency weakening and sticky inflation mechanisms (in services and administered prices) could spoil the inflation picture, the minutes suggest. At the end of the day, the inflation outlook is the ultimate driver for monetary policy decisions. But the COPOM seems to focus on the output gap as the key intermediate variable at the moment.

Slack in the economy to linger. The minutes highlight that the growth downturn “has opened up important slack, which will not be eliminated quickly in an environment of gradual recovery”. In other words, there are tentative green shoots of growth recovery, but not enough to feed inflation. Indeed, measures of the output gap in industrial production or in real GDP growth show plenty of slack. Likewise, industrial capacity utilization remains depressed. Looking ahead, as growth remains below potential, slack in the economy will likely linger. In turn, idle capacity curbs inflation and opens up room for further monetary easing – the minutes reiterate.

The resulting inflation outlook is benign, the minutes underscore. The central bank has cut its assumption on administered price inflation for 2009 to 5.0% from 5.5% before. Administered prices are a backward-looking – and thus more persistent – inflation component and account for about 30% on the IPCA index. The minutes have also revised down the central bank’s own headline inflation projections, which now stand “significantly” below the 4.5% target, the minutes emphasize. Market consensus inflation expectations for 2009 as well as for 2010 have fallen too – all below target.

The minutes say that the improving inflation outlook for 2009 and 2010 has not been incorporated so far in the yield curve. This is a surprisingly explicit statement. It is very unusual for the authorities to be so explicit about the yield curve, which the COPOM seems to judge is currently too steep. In our view, the COPOM controls the short-end policy rate but worries about the shape of the curve too, as it understands that the impact on the economy also works through the longer end of the yield curve. The curve had been pricing in a final 50bp rate cut at the next policy meeting in June, and then rate hikes by early next year. We suspect that the COPOM will prove more dovish than that.

Slower rate cuts for longer – this seems to be the message from the minutes. The COPOM sees incipient signs of growth recovery – hence the slower 100bp rate cut in April. But this does not mean that the monetary easing cycle is about to end soon. On the contrary, the COPOM seems to focus on the output gap, which the central bank itself recognizes will remain wide for a while.

Will the COPOM slow down further the pace of easing? The local yield curve foresees a 50bp rate cut in June. But we suspect that the market debate will migrate to the 50-100bp range for that meeting. Keep in mind that the June 10 meeting is just a day after the 1Q09 real GDP number comes out, and this looks set to be weak. Remember the March 11 policy meeting – back then, just a day after a nasty 4Q08 real GDP number came out, the central bank actually accelerated the easing pace to 150bp. Also, by the upcoming June meeting, the COPOM will have April activity numbers, which do not look great so far, judging from the deceleration in heavy vehicles traffic and outright sequential contractions in electricity demand, automobile output and sales.

We are fine-tuning slightly our interest rate forecast path, although the exact policy rate path remains uncertain and data-dependent. Our forecast continues to assume that policy rates fall by a total of 200bp from here, finishing 2009 at 8.25%. And we continue to look for a 100bp rate cut in June, but we now spread the subsequent remaining 100bp cut in two consecutive cuts of 50bp each – in July and September.

One caveat: Rules on savings accounts need to change as rates fall. The latest minutes reiterate a concern first expressed in the March minutes – as rates fall, the authorities worry about a potential migration of resources from fixed income funds into popular savings accounts, which are tax-free and offer a fixed rate. The minutes now say that this is a “pressing” issue, which hints that the COPOM foresees further policy rate cuts soon.

Economic Slack to Linger

Industrial production has recovered sequentially, month on month. IP increased by 0.7%M in March, below market expectations of 1.3%. March extends the sequential monthly gains seen in January (2.1%M) and February (1.9%M), after a worst-ever plunge last December (-12.7%M). The annual comparison improved to -10%Y in March, helped by calendar effects (two more working days from a year earlier), after record-low annual readings in January and February (-17%Y).

Still, IP bodes poorly for 1Q09 real GDP growth. Despite recent sequential monthly improvement after December’s plunge, the average IP level in 1Q09 is well below the average IP level seen in 4Q08. For 1Q as a whole, IP was -7.9%Q (not annualized), a decline comparable to the sequential plunge (-9.5%Q) seen in 4Q08. Looking at quarterly averages – which are what matters for real GDP – 1Q09 seems bound to bring yet another instance of negative sequential growth for real GDP. So, Brazil is almost surely already in technical recession. Real GDP posted a worst-ever plunge in 4Q08: -3.6%Q, not annualized. Our forecast has assumed real GDP growth of -1.8%Q in 1Q09, but it appears that it could turn out to be something like -3%Q or so. 

Most observers do not seem to have yet fully realized how weak Brazil’s economy already became around the turn of the year. The real GDP year-on-year comparison seems bound to worsen in 1Q09: it had already slowed from a booming 6.8% pace in 3Q08 to a meager 1.3% in 4Q08 – and it is set to dive decisively into outright negative terrain in 1Q09, in our view.

Ahead, the growth outlook remains uncertain. Sequential monthly IP recovery during the first three months of the year improves the picture for growth momentum coming into 2Q, but preliminary April proxies look soft so far. Looking further ahead, if previous cycles are any guide, it normally takes more than a year before IP recovers all the way to the peak levels prevailing before the turmoil hit. In sum, as the economy remains below its potential, Brazil’s (negative) output gap looks unlikely to disappear soon, in our view.

Bottom Line

The latest COPOM minutes send a clear dovish message: Lingering economic slack curbs inflation and supports further rate cuts. The central bank has slowed down the pace of easing in light of tentative signs of recovery, but still has work to do. Economic slack remains large, and will not be eliminated quickly in an environment of gradual recovery. In turn, slack pulls inflation down, opening room for further rate cuts. Unusually explicit, the central bank indicates that rates should go lower than markets have priced in.

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Korea
We Remain Relatively Constructive
May 12, 2009

By Sharon Lam & Katherine Tai | Hong Kong

Our new 2009 GDP forecast continues to stand above consensus: On the back of a faster-than-expected recovery and the continual supportive stance from the government, we are revising up our 2009 GDP forecast to -1.8% from -2.8% previously.  The market previously pointed at the possibility of a crisis and a deep recession in this export-oriented economy; yet, we had argued that Korea’s export slowdown would be milder than others due to its strong competitiveness. Since the country remains competitive, we expect the improvement in export momentum to continue to be in favor of Korea. Note that our forecast for Korea’s 2009 GDP growth has been above consensus (Morgan Stanley’s old base: -2.8% versus old consensus: -3.8%), and our new forecast will continue to stand above consensus despite the latest upgrades by the Street (Morgan Stanley’s new base case: -1.8% versus new consensus: -3%). Our 2009 bull case is 0.4% and bear case is -3.7%. We maintain our 2010 forecast at +3.8%.

Path of recovery: 1Q09 GDP surprised on the upside with positive sequential growth from 4Q08, which also means that Korea has technically avoided a recession. We expect the momentum to be even stronger in 2Q09 due to an improvement in exports. However, some temporary softening could be seen in 3Q09 as a stronger currency may reduce inbound tourism and its support for retail sales. We then expect stronger growth again in 4Q09 as the adjustment in capex and balance sheets should be behind us, leading to a more meaningful recovery in domestic demand coupled with an expected recovery in global economy at the same time.

Many green shoots: Korea’s leading indicators are rebounding, and the production/inventory cycle shows that the economy is at the beginning stage of a recovery. The worst of capex should also soon be behind us, and Korea does not suffer from overcapacity in this cycle. Construction has surged on government measures and the stimulus has helped to boost consumer confidence, while manufacturers are also upbeat about profitability.

Korea’s exports to remain relatively strong: The slowdown in Korea’s exports has been milder than in other countries in 2008 and so far in 2009.  We had been arguing that Korean exporters would be able to gain market share, albeit in a shrinking demand environment, which will help to fight against this global recession. Indeed, Korea’s share of the global export market jumped in 2008, and this trend has continued into 2009. With the gain in market share, Korea should be in a stronger position to recover faster than others when global demand normalizes. KRW depreciation has helped but is not the only reason why the Korean exporters outperformed, in our view. Korea’s export strength also came from its emphasis on R&D over the years, upgrading brand value, and its success in penetrating into high-growth markets, especially China. In particular, we have also been arguing that Korea will be one of the biggest beneficiaries of China’s stimulus package, as Korea exports for China’s fixed asset investment; thus, China’s loan growth is a good leading indicator for Korea’s export of machinery.  Although the KRW has appreciated recently, its current level still represents almost a 60% depreciation against the JPY, which will continue to make Korean products look attractive. We also do not expect further sharp appreciation in the KRW in the near term, as the current account surplus should narrow in 2H09 on higher imports as the economy recovers. We maintain our KRW/USD forecast at 1,250 by end-2009.

Retail sales to remain resilient in 2Q09, but may soften in 3Q before recovering in 4Q: Department store sales have been resilient in Korea, thanks to inbound tourism; however, the KRW appreciation could cause such an effect to peak soon.  In fact, the latest data suggest that inbound tourism is moderating, while outbound tourism saw signs of picking up, which could cause retail sales to soften. For consumption to fully recover, labor market conditions must improve. Korea’s labor market is already more stable than all other Tiger economies in the region, as its jobless number is the lowest, and employment growth for full-time workers remains in positive territory. However, due to the lagging nature of the labor market and the job sharing programs that secure employment with salary cuts, we believe that Korea’s labor market will not meaningfully improve until the global economy shows a more sustainable recovery, which could be in 4Q09-1Q10, in our view.

Interest rate to be on hold, but we do not rule out a high probability of rate cut in 3Q09: Korea’s liquidity growth has picked up slightly and inflation remains above the central bank’s target range, although we believe that CPI growth will trend down further in the coming months on a high base effect. Along with the faster-than-expected recovery of the economy, we believe that the Bank of Korea will likely keep the rate unchanged at 2% for the rest of this year until its hike in 1Q10. However, as we expect a temporary softening in growth momentum in 3Q09, we do not rule out the possibility of one more rate cut of 25bp in 3Q.

Government policies to remain aggressive and accommodative: Since late 2008, the Korean government has put together fast and aggressive stimulus measures from liquidity support to job creation to infrastructure projects in order to revive the economy. With a fiscal stimulus package estimated at 7.3% of GDP, the Korean government’s efforts lead most other countries in the region. Although the impact was already seen in 1Q09, the government continues to hold a cautious view on the economy, which we view as positive, since it means that government policies should remain supportive. About one-third of the original budget was used in 1Q09, and with the extra budget spending (roughly another 2% of GDP) approved in late April, the effect of the stimulus package is unlikely to die down for the rest of the year.

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United States
Review and Preview
May 12, 2009

By Ted Wieseman | New York

Treasuries have now extended their bear steepening sell-off to three weeks as the flood of supply, in amounts over the past two weeks that would have made up about a third of a full year’s issuance just a few years ago, and the promise of much more to come with the release of the Administration’s enormous 2010 budget plan – we continue to see the budget deficit running at US$1.6 trillion, or about 11% of GDP, in both fiscal years 2009 and 2010, which would lead to about a 20% rise in the Treasury debt/GDP ratio – have easily overwhelmed by far what taken by itself would seem to be aggressive offsetting Fed buying across Treasuries, mortgages and agencies.  The continuing surge in risk markets, with credit markets in particular absolutely on fire in the latest week, have certainly also provided a negative backdrop for interest rate markets, but in the latest week, it wasn’t until the situation at the 30-year auction on Thursday that the market broke down after having held little changed through Wednesday.  Treasuries have also been hurt to some extent by the ‘green shoots’ or ‘improving second derivative’ (choose your preferred overused phrase of the moment) but less so than risk markets it seems, as supply seems to be the predominant source of market pain at the moment.  The employment report by any reasonable assessment was absolutely terrible, and Treasuries received a bit of a boost Friday in response after Thursday’s supply-driven collapse, even as some analysts, reporters and investors in other markets were somehow managing to call one of the largest payroll declines in history and another half-point surge in the unemployment rate to a 26-year high signs of economic improvement. What can you really do but shake your head in disbelief at the Bloomberg headline “U.S. Loses 539,000 Jobs, Fewer Than Forecast, in Sign Economy Stabilizing”.  Certainly, the pace of decline in the economy does seem to be moderating – and if it weren’t after the 6%+ collapse in real GDP over 4Q/1Q, we’d be well on our way to a second Great Depression – but many key economic indicators at this point, at best, have moved to varying extents from disastrous to just terrible.  It would be hard to describe the employment situation at this point as even showing that extent of improvement, but the non-manufacturing ISM, like the previously reported manufacturing version, did move up into the low 40s in April, still holding well below the 50-breakeven level but at least up from previous abysmal lows in the 30s.  Consumer spending results in April were mixed – auto sales retrenched nearly to the February low after a March bounce, but chain store sales, while weak in absolute terms were a bit better than feared – suggesting that retail sales were probably stagnant in April, which is bad news compared to the brief rebound early in the year, but at least a notably less bad trend than the near-record collapse in consumption in 2H08.  After a further period of economic contraction through the summer, though certainly at a slower pace than 4Q/1Q, we do continue to see monetary and to a more limited extent fiscal policy gaining traction by year-end and leading to a return to tepid growth starting in late 2009 and continuing through 2010 (before massive tax hikes and rising rates potentially spark another recession in 2011).  But a lot of work still needs to be done in cleaning up the banking system and restarting securitization markets to allow policy actions to gain much traction.  And the underlying economic backdrop for the consumer, housing market, inventories and particularly for capital spending continues to look quite poor as we wait for repair of the financial system to allow policy easing to gain more traction. 

On the week, benchmark Treasury yields rose 2-17bp, with the curve seeing another sizable bear steepening move that has moved 2s-30s up 46bp the past three weeks to a five-and-a-half-year high.  Although risk markets rallied strongly over the course of the week, with credit leading, and economic data were generally better than expected, it was clearly supply that was the market’s major problem, since all of the week’s losses came Friday after a mess of a 30-year auction that tailed an enormous 10bp on top of a 10bp cheapening going into the bidding.  The market ended very little changed every other day during the week and even managed to post small gains Friday as stocks were surging after being boosted by the weak employment report.  Clearly, interest rate and equity investors had quite different interpretations of the implications of the key jobs report.  On the week, the 2-year yield rose 6bp to 0.99%, the old 3-year 2bp to 2.39%, the 5-year 12bp to 2.15%, the 7-year 6bp to 2.78%, the old 10-year 12bp to 3.29% and the old 30-year 17bp to 4.26%.  Except at the short end, this left yields at new highs for the year after a rough stretch during the past two weeks’ flood of supply.  In sharp contrast, TIPS performed well in absolute terms, very well at the shorter end, and terrifically on a relative basis, driving inflation breakevens to new highs since September, as a broadly based commodity price rally was led by a more than US$5 a barrel gain in June oil to over US$58 a barrel, a high for the front month since November.  The 5-year TIPS yield fell 13bp to 1.08%, 10-year 3bp to 1.73% and 20-year 1bp to 2.45%.  Mortgages got off to a great start to the week after a poor showing the prior week, posting good gains through Wednesday while Treasuries barely budged.  But this upside was more than reversed when Treasuries reversed course Thursday, leaving yields on 4% MBS at the top of the roughly 3.85-4.05% range they’ve been in since the big rally after the March FOMC meeting.  It’s good news at least that mortgage rates aren’t backing up to new highs along with Treasuries, but quite disappointing that after a significant initial improvement to record lows, average 30-year consumer mortgage rates have now been stuck around 4.80% for going on two months, as the enormous deluge of Treasury supply has frustrated hopes that the Fed’s aggressively stepped up purchase programs might drive a quick move down towards 4.5%.  Agencies and TLG debt managed to hold in better and outperform Treasuries by a good amount.  With every bank seemingly eager to get out of the TARP program as soon as possible, the TLG program may have largely run its course, as the Treasury has made issuance of non-TLG debt a pre-condition for repaying TARP funds, perhaps creating something of a scarlet letter going forward for banks that continue to use the program.  It’s certainly been an amazing run for this debt since it debuted last year, though, with the initial 3-year issues sold late last year tightening from 200bp over Treasuries when they were first sold to only about 25bp now.  Also of note in the low-risk parts of the bond market has been a continued strong recent recovery by the previously struggling muni market.  Friday afternoon the 5-year municipal bond MCDX index was trading 28bp tighter on the week at 165bp, the best level since November after hitting a wide close of 291bp on March 9.  Even after the recent big rally, however, this index trades quite a bit worse than levels in the mid-40s seen a year ago when the MCDX market debuted. 

Although the extent to which the stress tests really signal the all-clear for the banking system, given the not very stressful assumptions built into the adverse economic scenario (we see the potential for enormous further losses under what we consider a more realistic economic bear case; for details, see US Economics: Credit Losses, Deleveraging, and Risks to the Outlook by Richard Berner, Betsy Graseck, and Viswanath Tirupattur, May 4, 2009) is debatable, a continued major improving trend in interbank markets, which spilled over into the latest week into a huge swap spread tightening, is sending an unambiguous signal of lessening pressures on bank balance sheets.  3-month Libor fell another 7bp on the week to a record-low 0.94%.  This lowered the spot 3-month Libor/OIS spread 4bp to 74bp, a low since last July and even a good 10bp better than levels seen in the weeks before the Lehman collapse in September.  An even more dramatic improvement continued to be priced moving further into the year.  The forward Libor/OIS spread to June fell about 12bp to near 61bp, September 15bp to 59bp, December 17bp to 66bp and March 16bp to 55bp.  3-month Libor has been steadily moving lower for a couple of months, but oddly swap spreads at the shorter end had been little changed for several weeks before suddenly plummeting when the record low was first printed Tuesday.  For the week, the benchmark 2-year spread plunged 13bp to 46bp and 5-year 10bp to 50bp, lows since before the financial turmoil began nearly two years ago in mid-2007.  Longer-end spreads, which have been more influenced by Treasury supply pressures than financing improvements, also continued moving lower, with the benchmark 30-year spread moving deeper into negative territory at -42bp and the 10-year spread at 12bp, probably well on its way to breaking below zero too if supply pressures continue to pummel the longer end of the Treasury curve. 

It was a very good week across the board for risk markets – although the impact on Treasuries appeared to be limited, given that all the losses for the week came in preparation for and response to the 30-year auction – but a huge improvement in investment grade credit was the most impressive move.  The current on-the-run series 12 IG CDX index was trading 20bp tighter on the week at 144bp late Friday, a 33bp rally in just eight trading sessions and down 58bp from the wide of 202bp hit April 2 since this series began trading in mid-March.  The prior series 11 was at 180bp Friday evening, its tightest level in seven months.  High yield also continued to perform strongly, with the HY CDX index tightening 91bp through Thursday to 1,029bp and then jumping another 1 3/8 points Friday.  The leveraged loan LCDX index also had a good week, but lagged high yield somewhat, thanks to a flat showing Friday as the HY CDX index jumped higher, tightening 90bp through midday Friday to 1,083bp.  Credit was more the leader in the latest week, but stocks certainly also continued performing very well, with the S&P 500 up 6% on the week to reach its best level since the first trading day of the year.  Financials continued to lead, with the BKX banks stock index surging 36% to now sit just 1% lower for the year after being down as much as much as 58% on March 6.  Meanwhile, after stumbling at the end of the prior week after a big recovery over the prior couple of weeks, the commercial mortgage CMBX market got back on track in a big way.  The AAA index surged nearly 5 points to 75.13 and the junior AAA 9 points to 35.25.  Interestingly, the lower-rated indices, which do not stand to benefit from the PPIP programs if they ever get underway, also performed very well, much better actually relatively to their more depressed levels, with the AA up 9 points to 23.77, A 7.5 points to 21.24, BBB and BBB- 4 points each to 15.17 and 13.96, respectively, and BB 0.74 points to 6.73.  To this point, this pattern has not been seen in the subprime ABX market.  The AAA index continues to very gradually but quite steadily improve off the lows hit a month ago, rising another point in the latest week to 26.81 from a trough of 23.10 hit a month ago.  Lower-rated ABX indices remain near their lows not much above zero, however. 

Key early economic data for April remained weak, though generally to a somewhat lesser extent than seen over the prior couple quarters, extending the recent trend.  The employment report was another disaster, notwithstanding a collapse in payrolls that wasn’t quite as horrendous as the prior few months.  The non-manufacturing ISM rose a bit further from the lows hit late last year but remained well in recessionary territory, tracking the recent performance of the manufacturing version.  Early indications of consumer spending from auto and chain store sales pointed to a further small contraction in retail sales on top of the renewed downturn in March that followed a brief recovery early in the year, leaving 2Q on pace for a small renewed decline in real PCE.

The April employment report extended a recent run of horrific releases that have all been far worse than in any month during the 2001 or 1990-91 recessions.  Non-farm payrolls plunged 539,000 in April, bringing the annualized decline over the past six months to 6%, the worst run in 50 years.  The slightly smaller drop this month than the prior five largely reflected a 72,000 gain in government jobs, as hiring for the Census began unusually early.  Almost all major private sector categories, including manufacturing, retail, construction, financial, business services, leisure and wholesale trade, continued to see severe weakness.  Other details of the report were terrible.  The unemployment rate surged another half-point to 8.9%, a 26-year high.  The unemployment rate appears likely to hit double-digits within the next few months and before this downturn is over seems increasingly likely to surpass the prior post-war high of 10.8% hit in 1982.  The average workweek was steady at a record-low 32.2 hours, so aggregate hours worked plunged 0.6%.  Aggregate hours in April were already 6% annualized below the 1Q average.  About the only good thing that can be said about this continuation of the nearly unprecedented drop in hours worked seen over past eight months or so is that it is at least outpacing the plunge in output to keep productivity growth modestly positive.  Meanwhile, average hourly earnings slowed to just +0.1% in April, causing aggregate payrolls, a proxy for total wage and salary income, to plummet 0.6%.  With inflation likely to be little changed, real wage and salary income in April likely posted a similar-sized collapse.  Real wage and salary income – the key driver of consumer spending, particularly during this period of plummeting consumer wealth and lack of credit availability – fell at a 7% annual rate in the first three months of the year, and these figures suggest that the weakness continued at a similar pace into April, with likely only a relatively small partial offset from minor adjustments to tax withholding schedules in April that begin to implement the payroll tax credit that was part of the fiscal stimulus plan. 

Performing roughly in line with the previously released manufacturing survey, the composite non-manufacturing ISM index rose 3 points to 43.7 in April, still well in recessionary territory but more than reversing a pullback over the prior couple of months to reach the highest level since October after having now improved six points off the all-time low of 37.4 hit in November.  Upside in April was led by less negative results for employment (37.0 versus 32.3) and orders (47.0 versus 38.8), with the former remaining at a severely depressed level but the latter approaching the 50 breakeven level.  Recession was less broadly based by industry, with 11 of 18 industries reporting contraction in April, down from 17 in March. 

Early indications for consumer spending in April were somewhat mixed but overall suggested little change in retail sales.  After bouncing to a 9.8 million unit annual rate in March from the post-1981 low of 9.1 million hit in February, motor vehicle sales resumed sinking in April, falling to a 9.3 million unit rate.  Meanwhile, chain store sales results were soft overall in April, particularly with the boost from a later Easter, but not quite as bad as expected.  Taking these two results together and assuming some price-related softness in gas station sales (prices at the pump have recently been rising but not as much as they typically do this time of year, so the seasonal factors will depress sales results), we see retail sales overall and excluding food and energy being close to flat in April.  After the renewed weakness in March to end 1Q that followed a brief rebound in January and February after one of the worst holiday shopping seasons ever, this would keep 2Q real consumption on pace for a small renewed contraction. 

That April retail sales report, due out Wednesday, highlights a fairly active week for economic news.  With a break in Treasury issuance and another couple rounds of Fed Treasury purchases, the Treasury market might have a stronger tone in coming days, as it has tended, ceteris paribus, to do better during the generally alternating weeks with Fed buying and no new coupon issuance and selling off during supply weeks.  Other data releases due out include the trade balance and Treasury budget Tuesday, business inventories Wednesday, PPI Thursday and CPI and industrial production Friday:

* After being more than cut in half over the past four months, we look for the trade deficit to widen by US$5 billion in March to US$31 billion, reversing half of last month’s plunge, with exports falling 1.3% and imports rising 2.2%.  Exports are likely to be depressed by softness in capital goods (ex-aircraft), price-related weakness in food and a reversal of a spike last month in the volatile drugs component. Meanwhile, on the import side, upside in prices and volumes should result in a bounce in petroleum products from March’s five-year low, while port data point to some improvement in non-energy goods imports following a collapse over the prior few months.  Note that our March deficit forecast is somewhat wider than what the BEA assumed in the advance GDP report.

* We expect the federal government to post a US$10 billion budget deficit in April.  The Treasury usually records a sizable budget surplus in April, reflecting the receipt of annual tax payments by individuals and corporations.  However, tax payments are down considerably relative to recent years, while refunds and spending are rising. Specifically, April 15 tax payments by individuals were down about 35% relative to the same period a year ago.  This is very close to our initial expectation but it still represents a major swing factor relative to the normal April performance.  Also, corporate tax payments continue to decline.  We still expect the budget deficit to be close to US$2 trillion this year, but it will take a rapid pick-up in TARP-related spending to reach that threshold.

* We forecast a 0.3% decline in retail sales in April.  The reports from carmakers point to a drop in the auto dealer category this month.  Meanwhile, the chain store results were better than anticipated.  So, we have boosted our assessment of non-auto sales to 0.0% (versus our preliminary estimate of -0.3%).   And it’s worth noting that the expected flat result includes the impact of a price-related decline in gas stations.  In the key discretionary categories, we look for a solid rise at clothing outlets.  And we also expect an above-trend gain at the drug stores.  Finally, note that we see real consumer spending declining about 0.5% in 1Q.

* The results that have already been reported for the manufacturing and wholesale sectors, together with an anticipated decline in the retail component, point to another sharp 1.3% drop in overall business inventories in March.  However, the drop in April sales was even larger.  So, the I/S ratio is expected to tick up to 1.44 – which is quite elevated relative to the long-term trend.

* Following a sharp drop in the headline producer price index in March, we look for a fractional 0.1% uptick in April.  In particular, the energy sector is expected to flatten out, as a sharp decline in quotes for natural gas is expected to be about offset by a rise in gasoline.  Meanwhile, further softness in motor vehicle prices should help to restrain the core to a flat reading. 

* We expect the consumer price index to be down 0.1% overall in April and flat ex-food and energy.  Gasoline prices posted a significant decline in April after accounting for seasonal adjustment.  So, we should see another decline in this month’s headline result.  Meanwhile, the core is expected to show some sequential moderation tied to further softness in categories such as hotel rates, airfares and used cars.  Moreover, cigarette prices should flatten out this month following a sharp jump in March that was driven by a hike in the federal excise tax. Finally, the core reading is expected to hold at +1.8% on a year-on-year basis.

* The labor market data revealed that hours worked within the manufacturing sector dipped 0.9% in April – the smallest drop since last July.  Factoring in an anticipated boost from rising vehicle assemblies, we look for industrial production to be down only 0.2% in April, with the key manufacturing component slipping 0.1%.  We expect to see further weakness in sectors such as fabricated metals, furniture and apparel, but partially offsetting gains are anticipated in food and petroleum.

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