Updated from 1:52 p.m. EDT
A strong rebound in manufacturing activity was evident Wednesday in the sharp increase of durable goods orders in June. The report confirmed a still-brightening economic picture, but also that the
is not about to relax its campaign to raise short-term rates.
Adding to the bright economic picture, the Federal Reserve's beige book, a survey of economic conditions in the Fed's 12 districts, showed broad strength continuing through the middle of July. Stocks and bonds gained ground as the report also showed inflation pressures remained contained.
But if anyone still had any doubts about the Fed's will to lift interest rates, the report that new-home sales unexpectedly jumped to new highs in June likely silenced the end-of-rate hikes theories.
According to the Commerce Department, orders for durable goods -- which include such items as aircraft, computers and washing machines -- rose 1.4% in June, and were up 2.6% without accounting for a drop in the volatile transportation sector. The gains were well above Wall Street's expectations for overall orders to dip 1.0% in the month, and for orders ex-transportation to rise 1.0%.
May orders also were revised higher by 0.9% to 6.4%. In June, the backlog of orders increased by 2.6%.
Outside of the defense industry and aircraft, there was a sharp rise of 3.8% in business orders for capital goods, following weakness since January.
This "provides reassurance that overall capital spending is likely to resume the growth pace seen from mid-2003 through last year," according to Bank of America senior economist Peter Kretzmer. "Paced by much stronger orders of machinery, computers and electronics, the June orders rise points to continued robust capital spending on technology items later in the year."
Bonds came under renewed selling pressure after the durable goods data but recovered some ground after the Beige Book report noted no recent rise in inflationary pressures. The benchmark 10-year Treasury bond, previously down 7/32 was recently down 5/32 and the yield at 4.25%.
Major averages also gained after the Fed's report; as of 2:45 p.m. EDT, the
Dow Jones Industrial Average
was up 0.5%, behind strength in
, while the
was up 0.3% and the
up 0.4% behind strength in stocks such as
and despite pronounced weakness in
after its disappointing guidance.
Yields on the Run
Treasuries have been declining, and yields rising, since the Fed indicated no reprieve in its year-long rate hike campaign at the end of June.
Beyond the "initial shock" over the durable goods report, 10-year bond yields will likely stay close to current levels and below 4.3%, according to Larry Berman, fixed-income strategist at CIBC World Markets.
"The bond market will be in a dull phase for the next couple of months as
the Fed continues to raise," he says. "It would take other factors, such as core inflation picking up, to move to 4.90%."
That could very well happen if businesses do pass along higher input prices, most notably for energy. According to the beige book, price pressures have remained contained through mid-July, with only the transportation sector successfully passing along higher energy prices to consumer.
The survey said that wage pressures remain contained. But the report did note that the labor market keeps tightening. The Fed has made no secret over its wish to stay ahead of the curve on inflation.
And there are other key factors. China's step toward revaluation of the yuan is adding to uncertainty over Asian central bank purchases of Treasuries, which have put downward pressure on bond yields over the past few years.
Another key factor that should convince the Fed to continue raising well into next year comes from the red-hot housing sector, which shows no sign of abating. That will likely cause more alarm at the Fed, especially as the rest of the economy appears back on track.
The uptick in the yield of the benchmark 10-year bond, which is used to set mortgage rates, should in theory start putting some pressure on demand for mortgages and homes. But that still wasn't the case in June. Two days after reporting blowout numbers on existing home sales in June, the Commerce Department said Wednesday that new home sales also soared in the month.
New home sales rose 4% in June to a new record annual rate of 1.37 million. Economists on average expected sales to drop to 1.29 million in June after hitting a record 1.32 million in May.
The increase in sales should be close to a top as mortgage applications have started peaking, says Ian Shepherdson, chief economist at High Frequency Economics. "Still, there is no reason at all to expect any significant decline in sales unless and until there is a meaningful, sustained rise in mortgage rates," he says.
Joel Naroff, president of Naroff Economics, says the ambiguity of language to describe the housing market should be abandoned at this point. "There is a difference between a hot market and an 'out of control' market," he wrote. "We seem to have moved into that latter category."
The latest unexpected surges both in existing and new home sales are indications that people are starting panic and are trying to get into the market and buy a home before being unable to afford one.
"Economists say inflation is the worst thing to happen to an economy because people start making decisions based on rising prices not fundamental factors," Naroff says. "Welcome to our worst nightmare: It is the housing market."
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;
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