Week ahead in US financial markets
By Joseph Brusuelas

The major market moving releases of the week will be the FOMC statement on Tuesday and the publication of the consumer price index on Wednesday.  The only Fed speaker scheduled is the Federal Reserve Bank of Chicago president Charles Evans, who will speak on the economic outlook at a Swiss National Bank conference. Time to be announced.

Monday 8:30am (all times eastern daylight)
Empire Manufacturing (September)
Consensus 1.5, Merk 4.1, Prior 2.8

We expect the second consecutive increase in the New York Fed's estimate of manufacturing activity in the northeast. Our forecast implies that the headline should increase 4.1 on the back another decline in the prices paid component and a slight rebound in the new orders category. The break in the upward trend in input costs has provided some relief for manufacturers and demand from abroad should add an element of demand contributing to the modest increase in the headline.

Tuesday 9:15am
Industrial production/Capacity utilization (August)
Consensus -0.30%/79.60%, Merk -0.20%/79.60%, Prior 0.20%/79.90%

External demand has been one of the few bright spots in the economy over the past several months. But, the cooling in demand for commodities in August, should act as the primary catalyst for the -0.2% decline implied by our forecast. Thus, capacity utilization should decline to 79.6 for the month. The risk to our forecast is that demand for utilities during the final month of summer could swing the headline back towards a positive reading. Overall industrial production remains weak and outside of external demand there is little to support any short-term recovery in the prospects for the manufacturing sector.

Tuesday 8:30am
Consumer Price Index (August)
Consensus 0.00% (m/m), Merk 0.00%, Prior 0.80%

We expect that the headline inflation will hold steady at 5.6% on an annual basis and see no increase for the month of August. The core should see an increase of 0.2% m/m and move to 2.6% y/y, with risk to the upside on the monthly estimate. The CPI headline estimate has seen a 10.6% on a three-month annualized basis while the core has increased 3.5%, the ex-food component 10.9% and the ex-energy estimate has advanced 4.2% over that same time frame.

The past three months have seen core prices in particular begin to advance. On a three-month annualized basis the cost of services is up 6.2%, housing 6.5%, apparel 4.2%, education 5.5%, medical care 2.4% and tobacco 14.9%. The only significant category inside the CPI that has fallen is the cost of computers which has declined 15.7%. Perhaps, more interesting than the data itself, will be the market response to it. The market has discounted the rise in core prices that we expect to define the remainder of the year on the rosy assumption that headline costs will continue to decline allowing the Fed to ignore what we think will be continued pricing pressure in the core.

Tuesday 2:15pm
FOMC meeting
Consensus 2.00%, Merk 2.00%, Prior 2.00%

The Federal Open Market Committee meeting should see the committee hold rates steady at 2.0%. We expect that the fragility in the financial sector should remain front and center among many concerns at the Fed. We expect language in the monetary statement to support the recent actions taken by the US Treasury with explicit reference to the narrowing of spreads and decline in the 30-year fixed mortgage rate. The assessment of risks should remain balanced between growth and inflation. Although, the Taylor Rule implies that monetary policy remains accommodative by at least 150 basis points, the fragility of financial system dictates that rates remain on hold regardless of the upside risk to inflation.

Wednesday 8:30am
Current account balance (Q2 '08)
Consensus -$179.4b, Merk -$177.8b, Prior -$176.4b

The current account deficit should increase to $179.7 billion on the back of decline in investment flows into the US and soaring oil and commodity prices throughout the sampling period. The decline of the dollar and robust external demand for domestically produced goods have partially offset the sharp increase in the cost of oil during the quarter, but we still anticipate that the current account will deteriorate for the second consecutive quarter. The US requires $1.9 billion per day to bridge the gap between what it spends and what it saves. A healthy skepticism regarding the ability of the US to sustain such a large deficit is at the heart of our long-term bearish outlook on the dollar.

Wednesday 8:30am
Housing starts/building permits (August)
Consensus 950k/925k, Merk 985k/920k, Prior 965k/937k

We think that housing starts are at or near forming a bottom. The 965,000 that the market observed in July represent the weakest month in starts since the January of 1991. The environment for starts has not seen such sustained weakness since the twin recessions of the early 1980. Given the current level of household formation we do not think that starts will decline toward the mid 800,000 levels observed during the searing economic downturn observed in 1982. Permits should fall to 920,000 for the month.

Thursday 8:30am
Initial jobless claims (week ending Sep 13)
Consensus ---, Merk 440k, Prior ---

Over the next several weeks look for the weekly claims series to be quite volatile on the back of dislocation in the labor sector due to the series of hurricanes that have and look to hit the Southeast portion of the United States. Thus, the headline data will see risk to the upside over the next few weeks followed by a correction. More importantly going forward will be the continuing claims series. The series has trended upward and now stands above 3.5 million. We expect that jobless claims will fall slightly to 440,000 and the continuing claims should rise to 3.65 million.

Thursday 10am
Philadelphia Fed (August)
Consensus -10.00, Merk -11.49, Prior -12.70

The industrial picture in the Mid-Atlantic region continues to see contraction. The six-month average inside the Philadelphia Fed's survey of manufacturing activity stands at -17.3, which is reflection of the slowdown among regional manufactures. We expect the September headline to see a bit of improvement to -11.49 mostly due to the easing of commodity and basic input prices. However, the data inside the survey continues to underperform with the new orders category remaining weak and the employment indicator seeing contraction for the past six months.

Joseph Brusuelas is chief economist at Merk Investments.

(Copyright 2008 Merk Investments LLC.)