‘Ugly’ manufacturing data add to Fed dilemma

Posted on September 1, 2016

The US factory sector unexpectedly halted a five-month expansion in August, underscoring the difficult decision faced by Federal Reserve policymakers as they decide this month whether to increase interest rates.

The Institute for Supply Management’s purchasing manager’s index dropped to 49.4 in August from 52.6 the previous month. That came in well below estimates for a fall to 52 and the 50-line that separates expansion from contraction.

    Many of the individual components of the report were “ugly”, said Dennis DeBusschere, head of portfolio strategy at Evercore ISI.

    New orders and production went from expanding at a swift clip to shrinking modestly. Meanwhile, employment and inventories both declined at a faster pace.

    The report was a reminder that the “US manufacturing sector remains in an extended period of stagnation following a modest improvement in recent months”, said Michael Gapen, chief US economist at Barclays.

    Ward McCarthy, chief financial economist at Jefferies, echoed that sentiment, noting that the report “paints a murky picture for the near-term, but it is consistent with the volatile and fitful recovery that we have seen in the sector to date”.

    Indeed, manufacturers have been stung by a strong US dollar that makes American goods more expensive, a deep cutback in spending among energy groups and sluggish demand from abroad.

    A separate report on Thursday showed that labour costs rose significantly more than initially thought in the second quarter as compensation climbed and productivity fell.

    Output per hour among US workers fell at a 0.6 per cent annual rate, compared with a previous estimate of 0.5 per cent, said the Labor Department. Meanwhile, hourly compensation jumped to a 3.7 per cent rate, up from an earlier estimate of 1.5 per cent.

    “Increasing labour costs with slowing productivity will be a headwind for corporate profit margins and earnings growth moving forward”, said Mr DeBusschere.

    The divergent data highlight the difficult choice for Fed officials as they decide whether to raise interest rates this month for the first time since last December.

    On the one hand, policymakers are keen to make sure the economy does not overheat and cause inflation to rise too far beyond its 2 per cent target. But on the other, they have to consider the risk that higher rates could weigh on already fragile economic growth.

    “While the payrolls report [on Friday] will be the marquee swing factor for the Fed, they will certainly take notice of this report given the impressive track record of the ISM in predicting the tone of economic activity,” said Millan Mulraine, a macro strategist at TD Securities.

    The factory data caused the US dollar to surrender a 0.2 per cent gain against six global currencies, sending it falling 0.4 per cent in early afternoon action in New York. The two-year Treasury yield, which is seen as sensitive to monetary policy, declined 1.9 basis points to 0.78 per cent. Yields fall as prices climb.

    US stocks were also under pressure as investors digested the report, with the S&P 500 index declining as much as 0.6 per cent.

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