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Weekly Economic Vital Signs - Still No Rate Cut

by: Lawrence Fuller
Summary

This is a weekly series focused on analyzing the previous week’s economic data releases.

The objective is to concentrate on leading indicators of economic activity to determine whether the economy is strengthening or weakening, and the rate of inflation is increasing or decreasing.

This week, we examine construction spending, the ISM and PMI services and manufacturing indices, factory orders, and the jobs report for May.

Construction Spending

Construction spending has gone from bad to worse, as May saw a decline of 0.8% for the month with both residential and non-residential spending falling. Residential spending is now down 11.2% year over year, while non-residential is down 0.1%. Overall spending is down 2.3% year over year. The one area of strength this year has been public spending, but federal and state/local spending was also down for the month. The most surprising aspect of this report is the continued slide in single-family homes, despite significantly lower mortgage rates. It appears that rising prices in combination with a shrinking number of eligible buyers is the culprit in this category of construction spending.

PMI and ISM Services Indices

IHS Markit's (purchasing managers index) survey of service sector companies bounced off its 39-month low of 50.9 in May to 51.5 in June with a small increase in business activity, led by a pick-up in new business, backlogs, and employment. Regardless, business confidence hit a three-year low over concerns about new order growth and competition. The only positive here is that the increase in employment was consistent with what we have seen since the start of 2019, so no further deterioration.

The Institute for Supply Management's services index continues to show more strength than the Markit index, but it is weakening. The ISM slipped to 55.1 in June from 56.9 in May. This was the lowest level for this index since July 2017. Business activity, new orders, and employment were all weaker, while prices paid rose. This level corresponds with a GDP of 2.3%, which compares to the Markit index corresponding with a GDP of 1.5%.

PMI and ISM Manufacturing Indices

IHS Markit's manufacturing index bounced off its 10-year low of 50.1 to 50.5 in June. New orders rose slightly, but employment growth weakened to a three-year low. This index shows a manufacturing sector that is on the verge of contraction, but not just yet.

The Institute for Supply Management's manufacturing index continued its decline to 51.7 in June from 52.1 in May, which is confirming the weakness in Markit's survey. This index is now at a three-year low with new orders slowing to 50.0, which means flat month to month. Backlogs continue to contract in this survey, which does not bode well for future employment.

Factory Orders

Factory orders reflect the level of new orders for durable and non-durable goods. Orders fell 0.7% in May after declining a downwardly revised 1.2% in April. New orders for non-durable good declined for the first time this year, falling 0.2%, while durable slid 1.3%. A positive in this report is that business spending (non-defense capital goods orders x-aircraft) rose 0.5%. The ISM and PMI manufacturing reports for June don't portend an improvement in factory orders.

June Jobs Report

According to the BEA, payrolls rose a better-than-expected 224,000 in June. That includes the addition of 17,000 manufacturing jobs, which seems hard to believe, but remember that this is a backward-looking educated guess on job creation. The unemployment rate edged up to 3.7%, which is the result of new job seekers entering the labor force.

Wage increased 0.2%, resulting in a 3.1% increase year over year. Wage gains have stalled in recent months, but the rate of inflation has also tempered. The average workweek was unchanged at 34.4 hours.

Conclusion

Today's jobs report will make it far more difficult for the Fed to cut interest rates, but investors are still anticipating a 25 basis point cut at the next meeting on July 28. I don't think there was ever a consensus to cut rates, despite the certainty expressed in Fed fund futures. This economy is maintaining full employment and a rate of inflation that is very modestly beneath the Fed's target of 2%. There is no need for a change in policy, unless the Fed knows something that the consensus of investors does not.

Still, the rate of economic growth should continue to slow with one of the greatest headwinds being the surge in inventories that contributed to growth over the prior three quarters. The most significant variable will be trade, which is bound to become far more contentious and involve more participants before there is more clarity and progress.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.