West Texas ended the week at $69.24 per barrel and is sharply lower than the recent high of $77.03 per barrel for August 7.

STOCKS
Equities posted healthy gains last week except for a minor pause on Thursday. Lower oil prices pumped up stocks on Monday as Hurricane Ernesto moved away from oil rigs and production facilities. The technology sector was notably strong. Wal-Mart announced healthy revenues. On Tuesday equities slumped until the August 8 FOMC minutes were released in the afternoon, which markets read to mean that the Fed is finished with raising rates. On Wednesday, the upward revisions to GDP eased worries that the economy was too soft. Thursday, the markets saw a low core PCE deflator as positive but basically decided to sit on the sidelines until Friday's employment report. Stocks were boosted on Friday by the moderate gain in employment and low wage increase in August's employment report - thereby boosting the market's view that interest rates are only headed down from here. A sharp decline in oil prices also played a key role in lifting equities at the end of the week.

For the week, all major equity indexes were up. The Dow was up 1.6 percent; the S&P 500 1.2 percent; the Nasdaq 2.5 percent; and the Russell 2000 3.2 percent.

Year-to-date, the Nasdaq has come back strongly in August but remains down at minus 0.6 percent. But other major indexes are positive with the Dow up 7.0 percent, the S&P 500 up 5.0 percent; and the Russell 2000 up 7.2 percent.

For the month of August, equities were strong - notably in the technology sector and for small caps.

BONDS
Interest rates continued to fall. Generally soft economic data plus lower oil prices helped lower interest rates across the yield curve. Rates edged lower all week but the largest movement was on Thursday due to month-end positioning and in the context of an eased core PCE deflator.

Net for the week the yield curve was down from 5 to 10 basis points. The long end was not down as much as the short end partly because the long end had already slipped more in recent weeks. Declines for the various maturities were as follows: 3-month Treasury bill down 8 basis points, 2-year Treasury note down 10 basis points, 5-year note down 7 basis points, 10-year bond down 5 basis points, and the 30-year Treasury bond down 6 basis points.

Markets at a Glance

The Economy

Employment remains moderate, near potential
The jobs report for August clearly added to the view that the economy is slowing but remaining positive. Taken in the context of the economy being well into expansion, there are reasons to still see the August employment data as relatively healthy. Non-farm payrolls advanced a moderate 128,000 in August, following a 121,000 gain in July. However, August's rise was the second strongest in the last five months. The three-month average gain actually rose 128,000 in August from 118,000 in July.

Also, what some have forgotten is that at the peak of expansion, the jobless pool is smaller and there is not a lot of room for job growth without creating wage pressures. So, the recent moderate payroll gains are probably near the growth needed to stay at job growth potential - that is, staying even with labor force growth. However, the August dip in the unemployment rate from 4.8 percent in July to 4.7 percent indicates that even the recently modest job gains may be slightly too strong for labor force availability. Household employment rebounded 250,000 in August after July's modest decline of 34,000. Household employment is up 1.5 percent on a year-on-year basis - down from 1.6 percent in July. For August, the labor force increased 164,000, while the number of unemployed declined 86,000. The civilian labor force is up 1.3 percent on a year-on-year basis, lagging the 1.5 percent gain in household employment. Labor force monthly gains have averaged 180,000 per month over the last twelve months. So, employment gains in the 120,000 to 140,000 range are about what is needed to loosen the labor markets slightly.

Perhaps the only significant surprise in the August employment report was the softening in average hourly earnings. Hourly earnings edged up 0.1 percent in August, following a 0.5 percent surge in July. The August figure was well below the consensus expectation of a 0.3 percent rise.

Average hourly earnings are up 3.9 percent on a year-on-year basis - unchanged from July. Additional, softer gains similar to August's rise are needed to bring the year-on-year rate to a non-inflationary pace.

Personal income flies high, core inflation eases
The personal income report was quite robust for July, but compared with the August employment report is somewhat backward looking. Nonetheless, the personal income report paints the picture of a robust consumer sector - one that is quite strong for which August's moderation would be a good thing. Personal income rose 0.5 percent in July following a 0.6 percent increase in June. Within personal income, the large component of wages & salaries continued its healthy gains, rising 0.6 percent - the same as in June.

The consumer was quite willing to pull out the billfold or purse in July. Personal consumption for July jumped 0.8 percent, following a 0.4 percent rise in June. Strength in personal consumption was broad based but led by durables. Durables, nondurables, and services in July were up 1.6 percent, 1.0 percent, and 0.6 percent respectively.

The all-important wages & salaries component remains healthy with a 7.9 percent year-on-year growth rate. It is typical for the wages & salaries component of personal income to differ from the average hourly earnings series in the employment report. Somewhat simplified, the wages & salaries series is an aggregate for labor income and includes growth in numbers employed and growth in hours worked. The average hourly earnings series is merely an average for an individual hypothetical worker.

Other big news out of the personal income report was the slowing in growth for the core PCE deflator - a favored inflation measure of the Federal Reserve. While the overall PCE deflator rose 0.3 percent in July, the core PCE slowed to 0.1 percent. The core PCE deflator had risen two tenths of a percent or more for the prior six months. Year-on-year the core PCE deflator is still high at 2.4 percent - the same as in June and still above the Fed's target range. But as noted by the Fed's FOMC minutes released last week for the August 8 FOMC meeting, the Fed still is forecasting the core PCE deflator to ease in coming quarters.

Construction spending continues in two directions
Construction outlays came in a little weaker than expected - primarily in residential construction. Construction spending fell 1.2 percent in July, following a 0.4 percent gain in June. July's drop was the largest since the 1.3 percent decline in August 2001. While much is being made of the weakness in housing, not as much is being made - but should be - of the strength in nonresidential construction. In July, private construction fell 1.3 percent while public construction dipped 0.7 percent. As expected, private residential construction dropped 2.0 percent in July with single-family homes down 3.0 percent. However, nonresidential construction spending rose 0.3 percent in July, following a 3.7 percent jump in June.

While housing will soften GDP in coming quarters, nonresidential structures investment is coming in just as strong if not more so.

Corroborating the weakness in housing was the pending home sales index, which fell 7.0 percent in July to 105.6 and is down a very sharp 16 percent year-on-year. Declines were posted in all regions.

Private residential outlays are down 3.0 percent on a year-on-year basis while nonresidential outlays are up 22.0 percent from a year ago.

Manufacturing holds strong with only spotty weakness
We got updates in the week on manufacturing from the Institute For Supply Management report, the Chicago purchasing managers report, and from the full report on new factory orders. Note the Chicago sample includes both manufacturers and non-manufacturers as well.

In terms of overall activity, both the ISM and Chicago purchasing managers indexes edged down but remained in moderately positive territory. The ISM index slipped to 54.5 vs. 54.7 in July while the Chicago index edged lower to 57.1 from 57.9 in July. New orders were up in Chicago but down for the ISM. Backlogs were down in Chicago but up for the ISM - likely reflecting differences in shipment timing.

Prices remain an issue for both surveys, with indexes at very high levels. The ISM prices paid index stood at 73.0 vs. 78.5 in July. The Chicago survey's prices paid index edged down to 75.2 from 86.8 in July.

As expected the previously reported dip in durables pulled down overall factory orders 0.6 percent in July. The numbers were skewed lower by the typical volatility in aircraft orders. Autos were also weak but that also had been previously reported and is well known. Outside of transportation, orders were quite healthy. Excluding transportation, orders rose 1.1 percent. Additionally, aircraft backlogs are strong and new orders for aircraft are expected to rebound.

GDP is revised up much as expected
There was little new news in last week's revisions to GDP. Much as expected, second quarter real GDP was revised up to an annualized growth rate of 2.9 percent from the initial 2.5 percent estimate for the second quarter. The upward revision was primarily due to upward revisions in durables PCEs, nonresidential structures, inventories, government purchases, and exports. Partially offsetting these were downward revisions to business investment in equipment & software and residential investment as well as a small upward revision to imports.

On the inflation front, the overall GDP deflator was unrevised at 3.3 percent annualized - the same as the first quarter. The core deflator for PCEs - the preferred inflation measure of the Fed - was revised down slightly to 2.8 percent annualized from the prior estimate of 2.9 percent.

The main outcome of the revisions is that the economy is not as weak as previously feared. By time of the actual GDP revisions, the markets had already come to that conclusion. Looking ahead, the outlook is much as before. Moderate economic growth remains dependent upon a moderate consumer sector, healthy business investment, and a little help from exports.

Also released with the GDP report, corporate profits rose to a $1.349 trillion annual rate from the first quarter's $1.284 trillion. The second quarter figure sets another record high. Corporate profits are up 20.9 percent on a year-on-year basis. Corporate profits are strong and helping to fund investment growth.

The bottom line
More recent economic data clearly show some slowing in the economy. However, prior data show some sectors that are still very robust and there remains the issue of whether the most recent soft data are a trend or just noise around the strong prior trend. Essentially, is the consumer sector as soft as August employment report or really just as hot as July personal income and spending? Are hourly earning as soft as August or do we need to still worry about the longer trend? There seems to be little disagreement about housing weakening but there is debate over how much further it might weaken. Certainly, housing is in a much stronger position than in past tightening cycles. Unemployment is very low and jobs are still being created. Interest rates really are not that high. Manufacturing has healthy forward momentum as indicated by durables orders excluding the volatility in aircraft orders.

Overall, the economy is in good shape. At this point, a soft landing appears to be more likely than not. Continuing that analogy, the only question is whether the pilot (the Fed) needs to adjust the wing flaps a little or not. But for now, the economy seems on the right glide path.

On a final note, over the last two weeks there has been a sharp decline in the odds for any further Fed tightening in coming months. In fact, current implied rates for fed funds futures call for the Fed to start lowering interest rates this coming spring. Nonetheless, it bears remembering that Fed officials this past week continued to remind the markets that further Fed action is data dependent and that the decision to pause was a close call.

Looking Ahead: Week of September 4 to September 8

Next week is mostly a respite from economic news as the week starts with the markets closed on Labor Day. It is fitting, however, with Labor Day as part of the week that one of the key points of focus will be labor productivity & costs with additional labor information likely to be found in the Fed's Beige Book report.

Monday
Labor Day
Markets closed.

Wednesday
Productivity and costs
The Fed continues to rely upon productivity gains to help contain inflation. In the initial estimate for the second quarter, nonfarm productivity slowed to a 1.1 annualized percent rise from a revised 4.3 percent jump in the first quarter. With the upward revision to second quarter GDP we should see a modest upward revision in the productivity figure. Even so, unit labor costs are still quite high with an initial estimate of 4.2 percent annualized in the second quarter and this is not likely to be revised down dramatically.

Nonfarm Productivity Consensus Forecast for revised Q2 06: 1.5 percent
Range: 1.3 to 2.0 percent

Unit Labor Costs Consensus Forecast for revised Q2 06: 4.0 percent rate
Range: 3.2 to 4.9 percent rate

Beige Book
The Beige Book is the compilation of regional Federal Reserve Banks' anecdotal information on current regional economic conditions and is released two weeks prior to each FOMC meeting. FOMC minutes of the Aug. 8 meeting indicate that it was a close call on whether to pause or to continue to raise interest rates. Will the latest Beige Book validate the August decision to pause? Everyone expects residential real estate to be weak, but will moderation in the economy spread to other sectors? How tight are regional labor markets and what is the direction of inflation expectations?

The business activity index from the ISM non-manufacturing survey fell from June's 57.0 to 54.8 in July. Growth remains positive but notably soft. However, input prices remain quite strong with the prices paid rising to 74.8 from 73.9 in June.

Business activity index Consensus Forecast for August 06: 55.0
Range: 53.5 to 57.0

Thursday
Initial jobless claims slipped 2,000 in the Aug. 26 week to 316,000 while the four-week average rose 1,000 to 317,500. Overall labor market conditions remain on the soft side and are needed to remain so in order to help ease inflation. The market consensus expects this week's claims to maintain that trend.

Jobless Claims Consensus Forecast for 9/2/06: 315,000
Range: 310,000 to 331,000

Friday
Consumer credit rose sharply in June, up $10.3 billion and led by a $6.7 billion rise in revolving credit that followed a $7.4 billion increase in May.

Consumer credit Consensus Forecast for July 06: +$7.0 billion
Range: +$3.5 billion to +$9.0 billion