Vital Signs: How Bad Is the Damage to the Economy?

On deck: retail sales, producer and consumer price indexes, business inventories, industrial production, housing starts, consumer sentiment, Bernanke speaks, and earnings reports

by James Cooper

As investors await nascent signs that Washington’s massive and paradigm-shattering policy response to the financial crisis is working, they realize a great deal of damage to economies in the U.S. and around the world has already been done. In the coming weeks, the economic data will begin to show just how much. Several reports for September, due this week, will provide some early clues for the U.S., but the sharp credit tightening didn’t begin until mid-September, so its full impact will not begin to show up until the October reports.

Consumers had already begun to pull back on their spending in the wake of oil prices that peaked at $145 per barrel back in July. Weekly store surveys through September suggest the government’s roundup of the month’s retail sales on Wednesday will show a third consecutive decline. On Friday, the Reuters/University of Michigan index of consumer sentiment will offer the first broad look at how the crisis is affecting household attitudes and expectations.

Businesses will be front and center this week as well, especially manufacturers. After the stunning drop in September factory activity implied by the plunge in the Institute for Supply Management’s latest report, economists expect the Federal Reserve’s September index of industrial production to fall for the second month in a row. A national survey of small business sentiment through September, along with regional soundings from the New York and Philadelphia Federal Reserve districts in early October, will offer additional evidence on the degree of retrenchment by businesses.

The Fed’s Beige Book report, a region-by-region snapshot of economic activity prepared for the Fed’s Oct. 28-29 meeting, will be of particular interest, because it could provide additional evidence that would support another rate cut by the Fed. The markets are now betting on at least a quarter-point cut, to 1.25%, but many analysts believe the policymakers will go for another half-point reduction, given the deteriorating state of the economy.

The Fed will have the leeway to cut rates further because of the improving inflation outlook. Market expectations of inflation, measured by the difference between yields on a 10-year Treasury note and a Treasury Inflation Protected Security, have shrunk to levels not seen since the deflation scare ealier in the decades, especially given that oil prices are down some 40% since July. This week’s September reports on producer and consumer prices are expected to validate the more favorable inflation scenario.

Fed Chairman Ben Bernanke will be in the spotlight again this week, when he addresses the Economic Club of New York on Wednesday.

U.S. bond markets and government offices will be closed Monday in observance of Columbus Day (the stock markets are open).

Here’s the weekly economic calendar: