Equity futures are up following a late rally on Friday which pushed stock indexes to multi-year highs. The domestic futures market was bolstered by a 3% rise in China’s stock market last night. Benchmark interest rates suffered as a result.  Light trading flows and a lack of liquidity continue to play a role in exaggerating the speed and scope of rising interest rates. 

The 10-year Treasury yields rose 5 basis points overnight to 3.38%. That puts the note up 50 basis points in the past week and 70 basis points since QE2 set sail on November 3, according to economists at BMO Capital Markets.  “Even worse for the Fed is that long-term mortgage rates have jumped more than one-half percentage point in the past month, posing a threat to the still-shaky housing market,” they added.

The calendar of economic data was thin last week, but the next few days brings key numbers on retail sales, manufacturing and production, and cost pressures. In addition, the Federal Reserve releases a policy statement Tuesday afternoon. No changes to the QEII large scale asset purchase program are anticipated. HERE is the updated QEII Treasury purchasing scheudle.

Beyond the economic calendar, Congress goes on winter break starting Friday afternoon. That means Bush era tax cut and unemployment benefit extensions must be decided on in the days ahead, otherwise we will have to wait for the incoming 112th Congress to be seated

Key Events This Week:

Monday:

No significant data.

Tuesday:

8:30 ― The week begins with a look at the Producer Price Index, which at last glance was more subdued than expected. PPI is anticipated to rise 0.6% in November, following a 0.4% gain in October ― or half what economists were expecting. A 0.6% increase would leave prices up 3.3% compared to 12 months ago. Core prices, which exclude volatile food and energy costs, are expected to be up 0.2% in the month, after falling 0.6% in the prior month. For the year, core prices should be up 1.2%.

“Both food and energy prices look to have increased meaningfully, based on available exchange-traded prices,” said economists at Nomura Global Economics, who attributed the decline in October’s core PPI to vehicle prices on the annual auto year-end turnover. 

“This price decline is virtually certain not to be repeated, and the main question is whether the vehicle price indexes will settle at new lower levels or whether they will partially recover,” they wrote. “Investigating previous incidents of large October drops in the vehicle indexes, we judge that some payback this month looks likely. Besides this temporary volatility, we believe that core PPI inflation should hold relatively steady as higher input costs offset downward pressure from spare capacity.”

8:30 ― Rising consumer sentiment, Black Friday, and some holiday spirit are expected to boost Retail Sales, the key indicator this week, by 0.6% in November, following a 1.2% leap in October. The October gain was led by auto sales climbing 4.4%. Gains in November are expected to be more broad-based, as auto sales crept up only 0.1% in the month according to the Commerce Dept. The ex-autos figure, which moved up 0.4% last time, is anticipated to be up 0.6%. 

“Retail sales used to estimate consumer spending should be stronger than last year, especially general merchandise, apparel and accessories, furniture and other (GAFO) sales,” said forecasters at IHS Global Insight. “We are holding firm to our view that holiday sales ― November plus December retail sales less autos, less gas, less food services, less nonstore outlets ― will be up 4.5% compared to last year.”

10:00 ― Business Inventories are expected to rise 1% in October. The previous month rose a better-than-expected 0.9% as retailers stocked up more than forecasters assumed. The stock-to-sales ratio was unchanged at 1.27.

“The recent strength in inventory investment has clearly surprised us, and could suggest upside risks to our Q4 GDP growth forecasts,” said analysts at Nomura. “However, some of the gain looks to be related to price effects, rather than increases in real volumes.”

2:00 ― The FOMC Meeting always garners plenty of attention. This meeting will be no exception as analysts will want to see if the Fed’s language changes in light of heavy criticism recently regarding its reflationary program of quantitative easing. Also, the unemployment jumped to 9.8% in November, which should prompt the Fed to defend their monetary expansion policies. The overnight lending rate is not expected to be changed from the current range of zero to 0.25%.

“The FOMC may start to provide hints that it is prepared to be flexible in terms of the size and timing of the QE2 program, indicating that it could be ramped up or ramped down depending on the performance of the economy and other supporting fiscal policies,” said Fed watchers at IHS Global Insight. “Kansas City Fed Chief Thomas Hoenig will cast another dissenting vote, but that will be his last kick at the can for a couple of years, as he rotates off the FOMC board in early 2011. In 2011, the black sheep mantle will fall either to Plosser from the Philadelphia Fed or Fisher from the Dallas Fed.”

Economists at BMO added: "It’s possible that policymakers have become slightly more upbeat on the growth outlook in light of the tax-cut plan and generally better-than-expected economic numbers. However, we don’t suspect the better tone will discourage the Fed from completing its current asset-purchase program as planned through mid-2011."

"In fact," they continued, "since the last policy meeting, the Fed’s goalposts have moved further away, as core inflation has slipped to a record low and the unemployment rate has backed up. Rubbing salt in the wound is the fact that long-term interest rates, in particular mortgage rates, have jumped more than one-half percentage point since the November 3 policy meeting. The press statement should reaffirm that the Fed will do what it takes to reduce the unemployment rate meaningfully and return inflation toward 2%." 

Wednesday:

7:00 ― The weekly MBA Mortgage Applications index showed purchases were up 1.8% in the week ending Dec. 3, marking the third straight increase and reaching its highest level since early May.

“After several months of inaction, mortgage purchase applications have started to pickup,” said economists at Nomura. “Although this indicator has a spotty track record for calling turning points in the housing market, it corresponds with other tentative signs of improvement ― better pending home sales, stable building permits ― and therefore should be closely watched.”

8:25 ― Dennis Lockhart, president of the Atlanta Fed, speaks on Atlanta regional issues before the Midtown Alliance Annual Meeting.

8:30 ― The Consumer Price Index has been showing annual price changes at 1.1% to 1.2% for the past five months, while core prices are at just +0.6% ― the lowest level in 54 years of data. In November, monthly prices are set to gain 0.2% for the headline, the same pace as October, and 0.1.% for the core, which follows three flat months. Annual price gains are once again anticipated to be 1.1% for the headline and 0.6% for the core, levels that encourage the Fed to continue its QE2 program.

“We expect deflationary pressures to remain in the short- and mid-term,” said economists at BBVA. They noted that the gain in headline prices last month was driven by energy prices ― the rise in gasoline costs accounted for almost 90% of the increase.

Analysts at Nomura said the most important component of the core index to watch will be rent costs.

“In our view, available data suggest rent inflation has begun to pickup after a multi-year slump,” they wrote. “Given their large share (40%), an acceleration in rents could be enough to halt the decline in core inflation.”

8:30 ― The Empire State Manufacturing Survey, the first regional manufacturing report to be released each month, is anticipated to see a major leap forward to 5.0 in December, up from a contractionary -11.1 in November. The reversal is based on the view that the prior month’s plunge must have been a quirk ― the index fell from +15.7 to -11.1, its  weakest reading in 20 months and the biggest one-month decline ever recorded for the index. 

“We expect (and hope) this was a temporary drop, and forecast that the index will rise back to +5.0 for December,” said economists at Nomura. “Another weak reading would raise concerns about the ISM outlook.”

9:00 ― TIC Flows, a measure of what financial instruments are flowing in and out of the U.S., showed net cap inflows of $81 billion in September, with foreign purchases of Treasuries totaling $78.3 billion.  

Predictions for the October report were not available, but economists at Nomura released this note:

“In September, private foreign inflows into US capital markets were relatively weak ― less than half the volume of July and August. We expect private inflows to recover this month. The dollar started to recover during the month, and fund flow data showed a pickup in purchases of US bonds and equities. Separately, Fed custody data points to an improvement in foreign official inflows as well.”

9:15 ― Industrial Production was flat in October as a decline in utilities output offset a solid gain in manufacturing production. The Federal Reserve said warmer weather was the cause of reduced utilities output, so with weather back to normal economists are looking for a 0.3% gain in November. 

“Last month, industrial production was unchanged due to weather-related distortions, but manufacturing production was quite healthy,” said economists at Nomura. “This month, those weather effects should fade and the underlying heath in the manufacturing sector should show through. We look for particularly strong growth in auto production, given available production figures from the major manufacturers. Even stronger growth looks unlikely given the decline in manufacturing employment, the weaker manufacturing ISM, and a decline in electricity output during the month.”

Analysts at IHS Global Insight the electricity component should increase in November after a series of negative prints, while motor vehicle production will fall down after a sequence of strong months. 

“Core manufacturing probably had an average month as hours worked were anemic, but solid productivity growth allows output to rise faster than hours,” they said.

10:00 ― The NAHB’s measure of homebuilder sentiment, the Housing Market Index, is expected to remain stagnant at 16 in November after two months of single-point gains. Any score below 50 indicates pessimism, and while the current score is several points higher than summer levels, it is still below the pre-credit crisis all-time low. It is also below the 17 registered in November 2009. 

“The housing market has started to show some hints of improvement ― e.g., an increase in pending home sales and the week purchase application index ― but homebuilder sentiment remains extremely low,” said economists at Nomura. “We think the index could rise slightly this month as builders see more reason for optimism. We are forecasting a gain to 17 from 16, but see some upside risk to this figure.”

Thursday:

8:30 ― Economists are expecting to see a rebound in November Housing Starts, or plans for constructing new homes, after the index dropped 11.7% a month before. Starts are expected to rise to an annual pace of 550k in November, up from 519k a month before. Building Permits, which anticipate starts by a month or two, are forecast to be at 560k, up from 552k in October. 

At best, these increases are an indication of stabilization than a renewal in the sector. Over the past 24 months, the average starts rate has been 575,000 units, whereas under normal conditions it would be at least 1.5 million, according to economists at IHS Global Insight.

In October, single-family starts slipped 1.1%, while multi-family starts dropped 43.5%.

“The sharp 64,000 drop in October multi-family starts appears to be an aberration, since it is out of line with recent data points,” the economists said. “We are expecting multi-family starts to bounce back by half of this amount in October.”

They added, “Given that September's number was the  third lowest ever ― data go back to 1947 ― this is hardly much of an improvement. With the economy growing and adding jobs, and applications to buy homes rising, we are expecting a small improvement in housing permits.”

8:30 ― Jobless Claims are receiving a lot of attention recently as the 4-week average continues to fall, indicating that the pace of lay-offs is finally slowing and the economy is  actually creating jobs. Some are even predicting upward revisions to the disappointing payrolls report in November, in some part based on the jobless claims reports. Economists are looking to see 420k new claims in the week ending Dec.11, compared with 421k the week before. The 4-week average was 428k last week, or 22k lower than the 450k mark, the level which economists say indicates labor expansion.

“The week after Thanksgiving has one of the largest seasonal adjustment factors of the year and always should be treated with some caution,” economists from Nomura said of the latest 421k figure. “However, it seems clear that the trend in jobless claims is improving. We think further declines are more likely than increases over the next month.”

Continuing claims ― the tally of those receiving regular unemployment benefits ― are expected to come in at 4.05 million in the week ending Dec. 4, down from 4.086 million.

10:00 ― Forecasters think the Philadelphia Fed Survey will fall to 15.0 in December  from 22.5, indicating expansion but at a lower pace than a month before. The previous score was the highest in 11 months, and helped to keep markets optimistic after the sharp decline in the New York regional index. 

“In stark contrast to the Empire State index, the Philadelphia Fed's measure of manufacturing conditions surged in November back to its cyclical peak,” said economists at Nomura. “We see a modest reversal from current levels to 15.0, but think most of last month's gain will stick.”

2:30 ― The Federal Reserve Board holds an open meeting to discuss proposed rules governing debit card interchange fees and routing.

Friday:

10:00 ― Leading Economic Indicators, a composite measure that attempts to track turning points in the economy, is expected to rise by 1.1 points in November after gaining 0.5 points in each of the last two months.  A November gain would mark the fifth straight advance and point to continued economic expansion in the U.S.

Economists at Deutsche Bank say the index has been the subject of some debate recently because the annual rate of growth has leveled out since peaking in April. 

“We are not concerned as our expectation of 1.1% sequential growth in the LEI would keep the annualized rate of growth well above 6%,” they wrote. “We would only have reason to fret in the event that this series were to go negative on an annualized basis. This appears unlikely at least in the near term, given the strength in equities, steepening yield curve and falling jobless claims.”