The equity markets have all enjoyed a strong bounce since the US purchasing managers’ index for August was published yesterday. Expected to decline on the month, perhaps by a sizeable amount, the PMI actually rose from 55.5 to 56.3. After a long string of weak data, this is a sufficiently large surprise to pose the question: is the US economy really slowing as much as many of us thought? Maybe I am just stubborn, but this indicator has not been enough to persuade me to change my basic view.
Most of the monthly economic indicators (and there are more of them than ever – see this FT Alphaville comment) are little more than noise, which are just as likely to confuse investors as to enlighten them. However, once in a while, a surprise in one of the leading indicators turns out to be an early warning of a major inflexion point in the economy. The difficult trick is to know when.
The US manufacturing PMI survey is undoubtedly one of the small handful of critical global indicators published each month. Taken at face value, yesterday’s PMI is at a level equivalent to a real GDP growth rate running at about 3 per cent in the third quarter, which is about double the growth rate I thought we were likely to get. So why not revise the expected growth rate upwards?
There are two reasons for being cautious.
First, while the PMI survey may generally be the best early guide to the monthly behaviour of the US economy, it is not the only one. There are other monthly surveys, including three regional surveys published by the Federal Reserve banks of New York, Philadelphia and Richmond. These Fed surveys all fell sharply in August. The first graph shows that, taken together, they have historically tracked the PMI reasonably well, which is useful because they can be used to provide an independent cross-check of the PMI data. Using the normal statistical relationship, the Fed regional surveys suggest that the PMI “should” have been around 52-53 in August, substantially below the actual reading, and consistent with much lower GDP growth in Q3. So maybe the PMI was subject to statistical noise this month.
Second, the headline PMI reading sometimes give less information about the likely course of the economy than some of the detailed figures (like new orders and inventories) which are also published in the survey. In recent years, US economists have become focused on an index derived by subtracting the PMI inventory figure from the new orders figure, shown in the second graph. The idea here is that companies are likely to cut production when they see their unsold inventories rising while new orders are simultaneously declining. If we use the orders/inventory series to predict manufacturing output 3 months ahead, the implication is that the manufacturing sector might be suffering an outright contraction by the fourth quarter of the year. (Thanks are due to Kit Juckes of SocGen for pointing this out in recent research.)
Yesterday’s PMI survey was undoubtedly a favourable surprise on the US economy, and it would be churlish to suggest otherwise. But let us wait for some corroborating evidence before getting excited. Seen in that light, tomorrow’s employment data take on a new importance.
