ISM Index Factory Sector Falls Below 50: Indicates Contraction

For the second month in the last three, the Institute of Supply Management (ISM) reported that its Composite Index of Manufacturing Sector Activity was below the breakeven level of 50. The m/m decline to 48.3 was right in line with Consensus expectations for a drop to 48.4. Data points above 50 indicate growth in factory sector activity.

Last month's composite reading was down from 50.7 in January and 48.4 in December. The three month average level of 49.1 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 being constructed using all of the absolute positive changes in activity added to one half of the no change in activity measures.

Sharp declines in each of the five component series, excepting new orders, contributed to last month's decline in the composite index. Production fell 4.5 points and reversed most of its January recovery. The inventory component fell 3.7 points and reversed all of its January rise while the vendor deliveries component fell 2.7 points to the lowest level since 2003.

The employment index fell a sharp 1.1 points, repeating most of the January decline, to the lowest level since 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 new orders index fell a more moderate 0.4 points although domestic orders may have held up. The index of new export orders fell a sharp 2.5 points to 56.0, back to the average level during 4Q07 and 3Q07.

The prices paid index continued firm. A modest 0.5 point downtick during February followed very strong gains in three of the prior four months. That left the index at its highest level since August 2006. 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 Benefits of Systematic Monetary Policy is today's speech by Philadelphia Fed President Charles I. Plosser and it can be found here.

Growth in the Canadian economy slowed in the fourth quarter of 2007 to 0.79% at an annual rate, the slowest rate of increase since the second quarter of 2003 as can be seen in the first chart. For the year as a whole, GDP increased 2.65% compared with 2.76% in 2006.

In addition to the traditional quarterly series of GDP, Canada also maintains a monthly series that is less comprehensive than the quarterly series. The two series are compared in the second chart. The monthly series has been aggregated to a quarterly basis for comparison.

The monthly series shows that the rate of growth deteriorated sharply in the months of the final quarter. GDP in December was .67% below November, as can be seen in the third chart.

The strength of the Canadian dollar which has affected exports adversely and has encouraged imports has accounted for some of the slow down in the Canadian economy. Last Friday, Canada announced a deficit on its current account of $513 million Canadian, the first since the second quarter of 1999.

As a result of the slow growth, there is growing speculation that when the central bank meets tomorrow it will lower its target rate of 4%. The target interest rate of Canada is shown in the fourth chart with that of the United States.

The new FLASH estimate of EMU inflation stands at 3.2% year/year in February 2008 the same pace as in January. Germany's own headline rate rose by 0.2% in February and that is the rate implied by the new 3.2% for all of EMU (no month/month rate is released but one can be calculated form the released data but with less overall precision). Even with flaring oil prices headline inflation is not accelerating over the sequential monthly rates. AT 2.5% the 3-month pace is much better than the 4.3% over six months and 3.2% year/year but still above the ECB’s desired ceiling of 2%. German inflation data which are up-to-date show the same dampening of inflation trends. Italy does not.

The UK MFG sector rebounded slightly in February although it remains a weak reading for the sector at 52.26. Readings above 50 indicated expansion on this measure. The MFG measure stands in the 61^st percentile of its range, a moderately expansionary reading. Construction and services sector are still relatively weaker in their respective ranges but are as yet only available through January, not February.