ISM Manufacturing surprising on the upside
Contrary to the what has been seen in several of the regional manufacturing indices, and especially the Chicago PMI released last night, there was no evidence of a weakening in the manufacturing ISM for April, which rose from 53.4 to 54.8. The increase took markets by surprise as the consensus call was for a drop in the index to 53.0 – with the whisper number probably being even lower, as most forecasters most likely having reduced their bets following the weaker than expected Chicago PMI survey. The increase brings the ISM up to the highest level since June last year. Undoubtedly this will reduce fears that the manufacturing cycle has run out of steam, and the reaction in markets will most likely be on the positive side as it contradicts the less convincing recent economic data.
For now the outlook remains relatively solid...
The question at hand is how the index will move in coming months. In that sense, the rise in the forward-looking new orders index was reassuring, as it showed a rather steep increase from 54.5 to 58.2 in April – the highest level since April 2011 – in combination with a fall in the inventory index. As such, we asses that the risk of a pull-back below 50 in coming months is relatively small, but depending on the Euro area debt crisis over the next few months and also on whether the more negative signals from the labour market are sustained, we will not entirely rule out a scenario of ISM moving down towards 50. With regards to the latter, however, the rise in the employment index from 56.1 to 57.3 was encouraging, as it indicates steady growth in jobs in manufacturing, which has contributed by an average of 40,000 jobs/month in the first three months of the year.
...but manufacturing could still be running a bit out of steam
Despite the clearly positive number today, we are still hesitant with regards to expecting the ISM manufacturing index to stay at this level over the summer, as we see arguments for the ISM index to become more subdued in the coming months. First, in the last couple of years there has been a clear seasonal pattern, with ISM tending to overshoot economic development in the winter months, whereas it has tended to perform more weaker in the summer months. This is mainly due to the seasonal patterns being influenced by the recession in 2008/09, and even though the latest revisions of the seasonal adjustment factors seem to have reduced the problem somewhat, the seasonal pattern is still evident in the figures. Second, weaker demand from abroad is also likely to take its toll on the manufacturing sector (even though new export orders rose significantly from 54 to 59). Finally, the inventory restocking cycle also has potential to dampen industrial production, as inventories have been replenished quite significantly since destocking in Q3 last year. Remember that inventories added 1.81 percentage points and 0.59 percentage points to GDP growth in Q4 2011 and Q1 2012, respectively. Thus, for the moment we see that the more careful stance taken by Fed Chief Bernanke is justified, despite the stronger outcome today, and as such we expect the Fed to remain content with its current wait-and-see stance.