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US: Strong ISM indicates labour market stabilisation

Tue, Nov 3 2009, 08:14 GMT
by Peter Possing Andersen, Signe Roed-Frederiksen

Danske Bank A/S

• The US manufacturing ISM index improved to levels consistent with above trend growth.
• The strong headline was matched by equally strong details suggesting stabilisation in manufacturing employment and continued strong momentum in manufacturing production.
• Going forward, we expect the ISM index to improve further with a year-end target of 60 and indications of further strength in early next year. That said the details in today’s report suggest that the future pace of improvement is likely to be slower.

Details

The strength in the composite ISM index was accompanied by very solid details. All activity related to sub components has now returned to pre-crisis levels and is consistent with above trend growth.

The most significant positive surprises were evident in the production and employment components. The production index rose to 63.3 from 55.7, hitting its highest level since mid-2004. The index now suggests that hard data on industrial production will remain strong, with the annualised growth rate in manufacturing production remaining in the 10-12% range.

The increase in the employment index to 53.1 from 46.2 was even more noteworthy suggesting that the adjustment in the manufacturing employment has ended. The current reading is consistent with stable manufacturing employment and would usually signal positive readings in total private payrolls. However, we do not look for this to happen before year-end, but it will be important to watch the employment index in the non-manufacturing ISM.

The new orders index declined slightly to 58.5 from 60.8, but remains on levels consistent with solid expansion. Accompanied by a rise in the inventory index to 46.9 from 42.5, this suggests that the upward momentum in the ISM index has now peaked. Hence, we would not be surprised to see slower increases in the ISM composite in the coming months. Furthermore, if the inventory-order ratio continues to deteriorate, it would be consistent with a peak in the index arriving somewhere in late-Q1 or early-Q2 next year. On a positive note the customers inventory index continued down, which moderates some of the ‘negative’ signals from the deterioration in the new orders – inventory ratio.

Assessment and outlook

Going forward, we believe that there is more upside to the ISM index. Our hard-data based inventory demand ratio is to indicating a heavy production back-log in the US economy. This measure of future manufacturing activity is currently sending the most positive signal for the ISM seen in the past 40 years. Furthermore, this is supported by our model, which provides a year-end target for the ISM at 60 and indicates some possibility of even further strength early next year. That said, the recent deterioration in the ISM new orders-inventory ratio suggests that future improvement is likely to happen at a slower rate. In summary, today’s report underpins our forecast for around 4% GDP growth in the current and the coming quarters driven by substantial positive contributions from slower inventory depletion.

The reaction in bond markets was very muted confirming that macroeconomic data currently remains secondary to bond yields. As long as the Fed keeps any talk of policy tightening off the table and the appetite for fixed income remains strong, bond yields are likely to struggle to move any higher. However, as data continues to improve and the unwinding of quantitative easing moves closer we expect that bond yields will eventually rise.

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Published on  Tue, Nov 3 2009, 08:16 GMT