Friday, October 1, 2010

ISM indices continue to point to moderate growth

The September ISM manufacturing index was a tiny bit weaker than expected (54.5 vs. 54.4), but remains firmly in a range that in the past has coincided with 3-4% economic growth, as my first chart suggests. While this rate of growth is above the economy's long-term average of 3%, it nevertheless represents a fairly moderate recovery from a recession that was unusually deep. That's been the case for awhile, so in a sense today's report didn't change the outlook at all.

The export orders component (second chart) has weakened in recent months, but it too remains at levels that are consistent with economic growth, and it is far above any level that might suggest a double-dip recession.

The prices paid index jumped in September, and for my money it is signaling the existence of widespread and ongoing price pressures, something that is totally inconsistent with the Fed's and the market's preoccupation with how all the economic "slack" out there is deflationary. If the economy were even remotely on the cusp of a general and pernicious decline in the price level, you would think that some hint of that would be evident in this survey. But no, fully 70% of the ISM members reported paying higher, not lower, prices in September.

Finally, although the employment component of the ISM index dipped in September, it remains extraordinarily high. Since 1980, this index has only been higher in 14 out of 369 months. This suggests that the manufacturing sector continues to add jobs at a fairly impressive rate.

Adding it all up, the ISM report paints a solid picture of an economy that remains on a moderate growth track. Plus, it casts serious doubt on whether it makes sense for anyone—especially the Fed—to worry about deflation.


Buddy R Pacifico said...

The growth of the ISM and commodities at an all time high should put deflation worries at ease. The Fed is too occupied with the lack of wage pressure but other factors are much too strong for deflation.

Buddy R Pacifico said...

BTW, Scott your posts this week were at an all-time high for myself, since I started following.
Thank you.

brodero said...

I will confess i am troubled by
a couple of orders and inventories...I track the 12 month moving average of the
differential between new orders and
inventories...This average is now 11.7 and falling rapidly..A very
early warning sign is when this
average hits we have hit
7.5 and not had a recession but we have never had a recession unless this number was crossed first....hopefully we are seeing a mid cycle slowdown

Mark Gerber said...

70% of investment managers already believe QE2 is a done deal (according to CNBC/Steve Leisman's survey). As a result, it looks like the markets have begun to price this in already (stocks, commodities and gold up). When the fed looks through their economic hall of mirrors to make the final decision, they will conclude they now risk tirggering a stock market correction if they don't deliver. Therefore, it seems to me we are almost sure to get QE2 after the election.

You wrote that although you hope we don't get QE2, at least it will drive home the point that cash is trash. Since people in general tend to think in black-and-white, won't a rush out of cash and bonds cause rates to rise, gold and other commodities to spike, the trade weighted dollar to drop further and generally add lots of fuel to the simmering inflation expectations fire? With the Fed very unlikley to fight that fire until it is raging out of control, isn't this the beginning of hyperinflation?


Benjamin Cole said...

Okay, then, explain Japan in its 17th straight month of deflation.

How does that fit with the "commodities are signaling inflation" thesis?

Japan has been in near zero inflation or deflation for 20 years. How does that correlate with commodities prices?

Scott Grannis said...

Buddy: Thank you.
brodero: Interesting point you make; I think this is just one more sign that we had a bit of a slowdown in recent months, but nothing serious. Confidence fell in line with stocks, but now things are coming back.
Mark: I would agree that the market appears to have priced in QE2. But if the data continue to reflect a growing economy, and if that gives the Fed a reason to not go ahead with QE2, I have to think that would be a very positive development. Sure, we might see a brief disappointment selloff, but good data, a growing economy and a Fed that is less panicked would add up to a very bullish picture in my view.

Will we get a "rush out of cash?" So far it's been very gradual. But I do see the potential for a risky asset price "melt-up" if the data starts getting stronger. That would put the Fed between a rock and a hard place, since they would be reluctant to tighten. That revives memories of the 1970s, when the Fed was always slow to react and inflation kept ratcheting higher.

But hyperinflation? I don't see that. BTW, the definition of hyperinflation as I recall is when prices rise by at least 50% per month (10,000% per year). I've lived through hyperinflation in Argentina, and I find it hard to believe we could ever see that in the U.S.

Scott Grannis said...

Re: Japan, deflation and commodity prices. The BIG difference between Japan and the U.S. is the behavior of the two currencies. If you measure commodity prices in dollars and yen, you find this: over the past 5 years, commodity prices are up over 60% in dollar terms, but up hardly at all in yen terms. The yen has appreciated by enough to essentially eliminate the inflation signal of commodity prices. That is why Japan can have deflation while we have inflation. It's all about monetary policy.

Bill said...


I'd be interested in your reaction to the article in the WSJ which quotes an investor who's building his position in Japan, thinking that it will outperform in the coming years. Seems contrarian to the view that Japan's economy is dead.

Benjamin Cole said...


Okay, so it is possible--in fact we have a real world major industrialized nation experiencing deflation in the face of global commodities rallies (and collapses).

Japan's money policy is too tight. They have deflation and hit the zero bound. The tried fiscal stimulus, it didn't work. So they have done nothing, and that hasn't worked for 20 years. The central bankers are delighted with the 17 months of deflation, however. They have whipped inflation good.

We are an inning or two away from that.

The US monetary bulls are gaining strength, and the US economy appears to faltering again. I sure hope we see aggressive and confident QE2 from the Fed.

Inflation--bring it on.

Serious inflation now is about as likely as a forest fire in the dead of winter. In Canada. In a wet year. On a cold snowing night. When snow drifts are piling up. And icicles are hanging from the trees. And the barometer is plunging.

randy said...


I'm trying to understand why you say Japan did not try quantitative easing. Many other commentaries say otherwise. For instance, this from the Cleveland Fed:

After a series of fairly ineffectual policy actions, the Bank of Japan undertook its famous quantitative easing policy from March 19, 2001, to March 9, 2006. Under this policy, the Bank shifted its day–to–day operating target from the overnight, call–money rate to the level of current–account balances (reserves) at banks. Over the five years that the program was in place, the Bank of Japan raised its current–account target nine times. In implementing the quantitative easing policy, the Bank of Japan also increased its outright purchases of longer-dated Japanese government securities. The objective was to flood banks with excess reserves, which, of course, would keep the call-money rate at zero.
The Bank’s previous policy, maintained between February 1999 and August 2000, had been a zero interest rate policy, but the Bank had supplied only enough reserves to keep the call–money rate at zero. Hence, the quantitative easing was a more profound and visible policy shift.

randy said...


Can you comment on what happens if the US, Japan, and Britain all attempt to devalue at the same time? It seems to me that competitive / retaliatory devaluation has similarities to the infamous Smoot Hawley tarriffs. Someones currency has to go up but no one can afford it.


Benjamin Cole said...


I will read the report when I have time...the short answer is, they were timid, and no inflation resulted.

Listen, forever we have been told that central bankers not only can cause inflation, they usually do and have to be constantly on the lookout to not cause inflation.

Japan has had 20 years of deflation and zero inflation. You mean to tell me Japan's central bankers were serious about stimulating demand and inflation and could not do it?

Scott Grannis said...

randy: To begin with, I think the ability of major countries to devalue their currency as a matter of policy is vastly overrated. There is such confusion over this issue however. For example, Treasury is considered to be the custodian of the dollar. But ultimately the Fed is the only institution that can control the dollar's value (though they have never tried).

But if all major central banks tried to devalue their currencies, the result would be a global rise in inflation. The exercise would be pointless. It is always pointless, for that matter, to use devaluation as a tool to improve one's economy. It doesn't work, and never has.

Scott Grannis said...

randy: Re Japan. If I had to name the one thing that would make me bullish on Japan it would be this: the day they forsake the use of government spending to stimulate the economy, and instead vow to resort to tax cuts.

I do think that "stimulus" spending is futile at best, and most likely it only serves to de-stimulate an economy.

Scott Grannis said...

Oops, the previous comment was directed to Bill

Bill said...


Am I reading the historical ISM index to show that it can go down just below 47 before a recession takes hold? It also looks like it has gone up and down quite a bit even in the expansionary periods of the '80s and '90s. Am I missing something?

Scott Grannis said...

Bill: you are indeed correct. According to my eyeball, the ISM index can fall to 46 without signaling a recession or even a quarter's worth of negative growth. And it can be very volatile even during sustained expansions. For example, it fell from a peak of 70 in Dec. '83 to 47 in May '85, yet real growth was never below 3.3% during that time, and averaged about 5.5%.

As with all statistics like this you have to take them with a few grains of salt.

marmico said...

Good catch, brodero. It is always instructive to look under the hood.

This Danske Bank chart paints a troubling picture of the order-inventory ratio. After all, it states it right in the ISM Report:

Both the Inventories and Backlog of Orders Indexes are sending strong negative signals of weakening performance in the sector.