A quick look at a timely topic of interest – with a brief review of why it could matter to investors.

Chart of the Week

August 24, 2015

US manufacturing: no inflation pressure
US manufacturing sector: prices received and capacity utilization

chart

Source: Bloomberg, as of 7/31/15. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • The "prices received" component of the ISM PMI for US manufacturing—a gauge of manufacturer's pricing power—has been below 50 since last November.
  • Anything under 50 represents contraction—and with a reading of 44 for July, it's doubtful that the prices of manufacturer's goods, generally speaking, are heading much higher anytime soon.
  • What's more, the sector is still operating at a fairly low level of capacity utilization—76.2% in July. That means it can accommodate a significant increase in demand before it's necessary to expand current facilities, increase overtime pay or hire additional workers—developments that can lead to higher prices.
  • Couple those two things with a rising inventory-to-sales ratio—which means goods are accumulating on shelves faster than they are being sold—and it seems unlikely that production will ramp up fast enough to stoke inflationary pressures anytime soon.
  • Could this data cause the Fed to push back the first interest rate increase further into the future?
  • Obviously, it could. The state of the manufacturing sector directly bears on the Fed's dual mandate of promoting maximum employment and stable prices.
  • Still, even with weak inflation data, the Fed might also choose to move forward with an initial increase to demonstrate its resolve and maintain the credibility of its future guidance.
  • If it does choose the latter path, but inflation does not soon begin to rise toward its target rate of 2% then the gap between the first and second interest rate increase may prove wider than currently expected.

The chart:

  • The chart shows the Prices Received subindex of the ISM PMI for the US manufacturing sector and the Federal Reserve's capacity utilization rate for the US manufacturing sector over the past ten years.
  • Note that the Prices Received subindex has been below 50 for eight consecutive months.
  • The capacity utilization rate has not yet recovered to levels that existed prior to the recession of 2007-2009.

Definitions:

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The Institute for Supply Management (ISM) is an association of purchasing and supply management professionals, which conducts regular surveys of its membership to determine industry trends.
Purchasing Managers Indexes (PMI) measure the manufacturing and services sectors in an economy, based on survey data collected from a representative panel of manufacturing and services firms. PMI greater than 50 indicated economic expansion; below 50, contraction. The "prices received" subcomponent of the PMI for US manufacturing is a gauge of manufacturer's pricing power.


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