ISM Factory Sector Index Rose Unexpectedly; Level Still Indicates Contraction

The Institute of Supply Management (ISM) reported that during May its Composite Index of Manufacturing Sector Activity rose to 49.6 from an unrevised 48.6 in April. The latest was better than Consensus expectations which had been for an unchanged reading m/m. However, the index remained below the break even level for factory sector activity of 50 for the fifth month in the last six.

The index's average level of 49.0 so far this year was its lowest since early 2003.

During the last twenty years there has been a 64% correlation between the level of the Composite Index and the three-month growth in factory sector industrial production.

It is appropriate to correlate the ISM index level with factory sector growth because the ISM index is a diffusion index. It measures growth by using all of the positive changes in activity added to one half of the zero change in activity measures.

The new orders index rose slightly m/m to its highest level since November of last year. The reading was, however, near the lowest level since the recession year of 2001. The production index also rose very modestly for the second month. The inventory component and the supplier delivery indexes were roughly unchanged month-to-month.

The new export orders sub-series rose moderately to 59.5 which was its highest level since early 2004. During the last ten years there has been a 53% correlation between the index and the q/q change in real exports of goods in the GDP accounts.

The employment index was about unchanged at the low reading of 45.5, near its lowest level since mid 2003. During the last twenty years there has been a 67% correlation between the level of the ISM employment index and the three-month growth in factory sector employment.

The prices paid index rose again to its highest level since early 2004. During the last twenty years there has been a 77% correlation between the price index and the three-month change in the PPI for intermediate goods.

The NBER's Business-Cycle Dating Procedure is available here.

Manufacturing output weakened slightly in the Euro Area in May but the pace of decline is slowing. Among reporting countries the MFG PMIs mostly slipped in May. France and the Netherlands were exceptions, the Netherlands in the most trivial of ways.

Spain remains the mostly serious impacted of EMU countries with its MFG PMI in the bottom 2.5% of range constructed from early 2000 on. The overall EMU PMI is below breakeven at the 43.7 range percentile. France, Italy and Austria, too, are below their respective range midpoints. Germany’s standing at the 61.2 percentile of its range is astonishing. The UK, an EU only member, stands in the 42 percentile of its range.

For the most part these rankings reflect inflation rankings and therefore reflect competitiveness rankings within the EMU area. Greece, however, is performing in terms of its MFG PMI much better than its inflation ranking would have you believe it would. The rest fall more or less into line. (see inflation chart below for cumulative inflation on the national HICPs since July 2000).

The table shows that German inflation has risen by 4.4 percentage points less than EMU inflation during their period. Greece’s HICP has risen by 11.5% more than the EMU average. Spain is also an inflation leader and as expected it is an output laggard in this cycle as the euro has risen.>

On balance there is a great deal of irregularity within the Euro Area involving inflation performance and output results. Still there is only one monetary policy, making things difficult. The ECB is looking only at group inflation (EMU-wide) to make policy and holding to a firm path. Cracks in the Euro Area are beginning to form.

Inflation has risen sharply in most of the Far Eastern countries. Even those countries that had inflation rates below 3% in 2007--Singapore, Thailand, the Philippines and South Korea-- are now showing rates of inflation ranging from 4.9% to 8.35% in recent months. The first chart shows inflation rates in these four countries. Only in Malaysia, where inflation was 2.0% in 2007, is inflation still below 3.0%.

In April, China's inflation rate was 8.5% and in India, where the latest data are for March, the inflation rate was 6.0%. In other countries inflation rates are much higher. For example, in May, the inflation rates in Indonesia was 10.4% and in Vietnam, 25.3%.

In most Far Eastern countries the monetary authorities have kept interest rates steady in recent months so that most countries now have negative real interest rates. The second chart show some typical policy interest rates and the third chart shows real interest rates in China and India, which have recently become negative.