Data Complicate Fed's Agenda

Fed Chairman Ben Bernanke's theory about slower growth leading to lower inflation isn't panning out.
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After a rough start, Ben Bernanke seemed to find his footing this summer and has increasingly earned accolades from Wall Street for his stewardship of the U.S. economy. But it may be premature to give the

Federal Reserve

chairman a "rookie of the year" award, as

CNBC's

Larry Kudlow is fond of doing.

The data streaming in of late show the much-awaited landing -- soft or hard -- is really here. But the slowing economy hasn't eroded inflation, as Bernanke & Co. had hoped it would. The sticky mess of a tight labor market leading to wage inflation is stubbornly refusing to disappear, as evident in Thursday's third-quarter productivity and unit labor-cost data.

But despite angst over the data, the markets are holding up relatively well.

Major stock market indices have had a handful of down days this week, including Thursday. But the selling has been moderate and the

Dow Jones Industrial Average

is holding above 12,000. After trading as low as 11,979 intraday, the Dow rebounded to close down 0.1% to 12,018.54; the index is now down 0.6% on the week. The

S&P 500

dropped 0.03% on the day -- it's down 1.6% on the week so far -- to close at 1367.34. The

Nasdaq Composite

fell 0.01% to close at 2334.02, putting the index down 0.7% thus far this week.

As the pendulum swung back to the "glass half-empty" economic scenario, the bond market has rallied again to send yields to the lower end of their recent range, but not beyond. Indeed, bond yields rose Thursday based on the inflation signals that emerged from the productivity report. The 30-year Treasury bond fell 15/32 Thursday to yield 4.72%, while the 10-year note fell 8/32 to yield 4.6%; the five-year note dropped 4/32 to yield 4.55%.

"The Fed is getting exactly what it wants, a slowdown, and whenever you have a change in the direction of the economy, you'll get volatility," says T.J. Marta, senior fixed-income strategist at RBC Capital Markets.

Thursday's barrage of data painted a picture of rising labor costs combined with flat productivity, weak consumers and a jump in jobless claims.

"The inflation outlook is not so great," says Drew Matus, senior economist at Lehman Brothers. "But the growth outlook is not so bad."

The Labor Department reported that productivity in the third quarter was flat, as the tight labor market led to less output per worker. Economists had forecast 1.1% productivity growth in the third quarter. Embedded in the productivity report, unit labor costs rose 3.8%, higher than the 3.4% rise that economists expected. The jump means unit labor costs are rising at a 5.3% pace year over year -- the highest level since 1982, and well above the 20-year average of 1.9%.

The Census Bureau reported Thursday that factory orders grew 2.1% in the month, while analysts expected a 4% gain. Orders for August were revised to reveal a decline of 0.3%.

The report showed that manufacturing inventories rose for the seventh consecutive month, at a 0.6% pace in September. Behind the headlines, however, orders for nondefense capital goods, excluding aircrafts, jumped 2% in September. The same orders are up 13% on a quarter-to-quarter basis.

The report also showed "ample" increases in orders for aircraft, defense capital goods, communications equipment, construction equipment, industrial machinery, primary metals, and power generation equipment, among others. "That mouthful of sterling advances suggests that manufacturing will avoid a hard landing," says John Lonski, chief economist at Moody's Investors Service.

Perhaps the most unexpected and damning of Thursday's data points was soft October same-store sales reports, revealing that the problems at

Wal-Mart

(WMT) - Get Report

might not have been just about the firm's internal issues. Indeed, the Fed's pause is predicated somewhat on fears that the housing market could slow consumer spending too much. The consumer has held up quite well to date as long-term interest rates and mortgage rates remain low. But if consumers start to falter, the markets are bound to get increasingly worried.

Discount stores like

Target

(TGT) - Get Report

and

Costco

(COST) - Get Report

also reported disappointing sales for October. Shares of Wal-Mart and Target fell more than 1%, while Costco registered a 0.15% gain.

Specialty retailers reported disappointing sales as well, as shares of

Ann Taylor

(ANN)

and

Gap

(GPS) - Get Report

dropped over 4% each while

Chico's FAS

(CHS) - Get Report

shed 8%.

In a surprising twist, the only retailers that solidly beat expectations for sales were department stores. To wit, shares of

J.C. Penney

(JCP) - Get Report

and

Saks

(SKS)

added 2.58% and 1.62%, respectively. The S&P Retail Index declined 0.8% on the day.

The research firm Retail Metrics said 61% of retailers in its index reported weak October sales. The firm's retail index posted a 3.3% gain in October, compared with analysts' expectations for a 3.7% gain.

Continuing with the data parade, the October nonfarm payrolls report comes out Friday, on the heels of Thursday's rise in initial jobless claims. Economists expect the economy added 125,000 jobs in the month. Last month, the Bureau of Labor Statistics showed an addition of 51,000 jobs, but announced an 810,000-job addition to prior months' calculations. The ADP National Employment report, which was released Wednesday, said the economy added 128,000 jobs.

If weakness appears in the labor market, the markets won't be feeling any better about the growth-inflation game -- nor will Bernanke for that matter.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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