Bangkok--20 Feb--Standard & Poor's The World Buys American By David Wyss and Beth Ann Bovino The December trade deficit improved to $58.8 billion from $63.1 billion in November, reversing the widening of the previous two months, and is a piece of good news on an otherwise disappointing week. The slew of economic releases this week included: Federal Reserve Chairman Bernanke said that he sees "an improving picture" on the economy, but noted that "downside risks to growth remain,” to keep further easing an option. The U.S. Treasury ran a $17.8 billion surplus in January, half the $38.2 billion surplus a year ago. Receipts fell 2.1% over last year, while outlays were up 6.7%. U.S. import prices rose 1.7% in January over December. Export prices were up 1.2%. Retail sales rose 0.3% in January. Excluding autos and gasoline, sales were flat. U.S. industrial production rose 0.1% in January after a revised 0.1% reading in December (previously a flat reading. The capacity utilization rate held at 81.5%. The NY Fed Empire State index plunged to negative11.7 in February, from 9.0 in January. U.S. business inventories rose 0.6%, above the 0.4% rise in November and what markets had expected. Sales fell 0.5% in December, after the 1.4% surge in November sales (1.6% before). The University of Michigan consumer sentiment index plunged to 69.6 in mid-February. The current conditions index fell to 85.4 from 94.4, while the expectations fell to 59.4 from 68. U.S. initial jobless claims fell 9,000 to 348,000 in the week-ended Feb. 9. Continuing claims dropped 9,000 to 2.761 million in the week ended Jan. 26. The insured unemployment rate held at 2.1%. Holiday distortions were a factor, though the uptrend is a concern. The Bank of Japan's policy board voted unanimously to hold the benchmark short-term interest rate at 0.5% on Feb. 14. That rate is the lowest in the developed world. December net TIC flows were $60.4 billion, after $150.8 billion in November. Official accounts bought $52.1 billion, while private accounts bought $8.4 billion. Oil prices rose to $96/bbl (West Texas) on Friday. The 10-year Treasury yield edged up to 3.85%, and remains well below the 4.25% in early December. The dollar weakened to $1.47/euro but strengthened to 107.8 yen. Stock prices dropped sharply after a disappointing ISM services reading and hawkish Fed comments. Shopping Spree Abroad The narrowing of the trade deficit to $58.8 billion in December from $63.1 billion the month before was perhaps the most positive news of the week. The overall deficit is down $1.5 billion from last December. Imports dropped $1.1% to $203.1 billion, despite an increase in petroleum imports. Petroleum imports widened $1.5 billion, on record average oil prices but also more volume. Exports increased 1.5% to $144.3 billion, led by strength in industrial supplies (up 3.5%), capital goods (up 5.2%), and consumer goods (up 4.6%). In particular, a $948 million jump in civilian aircraft orders led export strength. Aircraft exports for 2007are up $8.0 billion (19.7%) from $32.1 billion in 2006. . The 1.1% drop in nonpetroleum imports was concentrated in autos, which plunged 9.3%, a bit of a surprise given the sharp jump in wholesale auto inventories in December (up 3.5%). Wholesale inventories of autos are entirely imports, because domestic cars go directly from the manufacturer to the dealer. This divergence is probably caused by seasonal adjustment and timing differences at the end of the year, and should reverse in the January data. The data outperformed the BEA assumption, implying that the contribution to fourth-quarter real GDP from net exports will be revised notably higher. The 2007 trade deficit narrowed 6.2% to $711.6 billion, down from a record $758.5 billion in 2006, and the first reduction in the annual trade gap since 2001. One-third of the U.S. trade deficit was accounted for by China. Canada, Mexico, and the OPEC countries together account for the same percentage, mainly because of oil. Deficits with Europe have narrowed. News on the other deficit was less upbeat. The Treasury reported a $17.8 billion surplus in January, less than half the $38.2 billion surplus a year ago. Receipts were down 2.1% from a year earlier while outlays rose 6.7%. The strong receipts suggest that the fiscal-2008 deficit will be substantially wider than the $163 billion deficit in 2007. Our current forecast is $411 billion, taking into account the fiscal stimulus package, and is surprisingly in line with the Administration’s estimate of $410 billion. April is the key month. For the first four months of fiscal 2008, the deficit will total $87.7 billion, compared with $42.1 billion for the same period in fiscal 2007 Import prices surged 1.7% in January, more than three times the 0.5% expected and the revised December reading of negative 0.2% (previously 0.0%). Petroleum import prices rebounded 5.5% and are up 66.9% over last year. However, nonpetroleum prices were up a solid 0.6%, to indicate inflation. The higher import price increase suggests that the January trade deficit should widen. Export prices jumped 1.2%, and are up 6.7% from a year ago. Agriculture prices climbed 5%, while nonagriculture prices were up 0.8%. We still expect the Fed to cut rates by 50 basis points (bps) in March, the signs of inflation reduces the likelihood of an April move. Where Did The Gift Cards Go? Retail sales rose 0.3% in January, after falling 0.4% in December. November retail sales were revised lower, to 0.8% from 1.0%. The Vehicle & Parts component surprisingly rose 0.6% despite a hefty 6% drop in unit vehicle sales. Timing issues or more High-end sales or used car sales may explain the discrepancy. The 2.0% rise in gasoline station sales was caused by prices. Excluding autos and gasoline, sales were flat in the month. Weakness was again concentrated in housing-related sectors, including furniture (negative 0.5%), building materials (negative 1.7%), and electronics and appliances (negative 1.0%). Besides autos and gas stations, there was a swing toward apparel (up 1.4%), away from department stores (down 1.1%), reversing December’s moves. Apparently, we used our gift cards for clothes (though not from Macy’s), especially given the weather and need for sweaters. The University of Michigan U.S. consumer sentiment fell to 69.6 in mid-February from 78.4 in January, and well below the 77 that markets had expected. Current conditions index fell to 85.4 from 94.4, while the expectations index fell to 59.4 from 68.1. The disappointing report adds further weight to the likelihood of a pullback in consumer spending this year.The manufacturing sentiment was also down. The New York Federal Reserve’s Empire State index plunged to -11.7 in February, from 9.0 in January and was much weaker than the 6.3 reading that markets expected. While a regional index, the sharp unexpected drop will add to the investors' recession fears for the U.S. U.S. business inventories rose 0.6%, above the 0.4% that markets had expected and the 0.4% rise in November. Sales fell 0.5% in December, after the 1.4% surge in November sales (previously 1.6%). The data boosted the inventory/sales ratio to a still lean 1.26 from 1.25 in November. This is in line with the solid Wholesale inventories reading the week before. The stronger than expected inventories data, together with the much more narrow trade deficit for December, will result in an upward revision to fourth-quarter real GDP, probably to about 0.8% from the meager 0.6% reported last month. Say Something Positive In prepared testimony to the Senate Banking Committee, Federal Reserve Chairman Bernanke focused on downside risks to growth, with few inflation comments, to suggest another rate cut in March. While he said that he sees "an improving picture" on the economy, he noted that "downside risks to growth remain, including the possibilities that the housing market or the labor market may deteriorate" further than expected. He also noted that "credit conditions may tighten substantially further". Mr. Bernanke said he expects inflation to moderate, though warned that increased inflation expectations could erode the "Fed's inflation-fighting credibility" and reduce the bank's policy flexibility. The chairman reiterated that the Fed will act in a "timely manner as needed to support growth and to provide adequate insurance against downside risks." Overall, Mr. Bernanke had no noticeable hawkish references, but instead focused on downside risks to growth, to increase the likelihood of a 50 bps cut on March 18th. In his comments to the Senate Banking Committee, Treasury Secretary Henry Paulson also acknowledged problems in the U.S. economy this week, but believes that the nation will avoid falling into recession, thanks in part to a series of interest rate cuts by the Fed and a $170 billion economic stimulus package signed by President Bush Wednesday. He conceded the economy faces additional headwinds. Standard & Poor's, a division of The McGraw-Hill Companies (NYSE:MHP), is the world's foremost provider of financial market intelligence, including independent credit ratings, indices, risk evaluation, investment research and data. 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