Following yesterday’s note we thought we would add a bit more flesh to the bones. There’s going to be a lot of second-guessing about the Fed’s next move if the data continues to run the way they have of late. Consumption and investment numbers have both dipped since officials pulled the trigger on 17 December last year. Yesterday we spoke about the ISM data with a December drop to 48.2, the lowest since June-2009. It was the second month in a row of sub-50 (contractionary) readings and it confirmed what the hard data have been showing for some time: the industrial sector is in a recession and it appears to be deepening. Manufacturing output hasn’t grown in three months and is up only 1% over the past year, and the broader industrial sector – which also includes mining and utilities – is much worse; with year-on-year (yoy) ‘growth’ of -1.2%.
This is not just about oil and commodity markets as reflected in the Dallas Fed survey of manufacturing which dropped to -20 in December from -5 in November. Elsewhere data is also not so positive and the recession in manufacturing is widespread; Chicago’s recent PMI release dropped to 42.9 from 48.7 and Kansas City’s Fed survey dropped to -9 from +1. On the east coast, the Philly Fed survey plunged to -6 from +2 and the New York Fed survey rose but only to a negative 4.6 from -10.7 in November.
Also yesterday we had the release of construction spending for November which came in at -0.4% from the +0.6 expected, with a revision to October to just 0.3% from the 1% previous release; this will cause big downward revisions to Q4’15 GDP expectations. In fact the Atlanta Fed ‘GDPNow’ forecast has dropped to just 0.7% for growth in Q4 from 1.3% on December 23 just after the Fed hike.
Sure enough the industrial sector recession is not deep and industrial activity accounts for ‘only’ 16% of GDP with the service sector is doing considerably better, but one-sixth of a nation’s GDP is nothing to be complacent about. The fact is that economic evidence is pointing the wrong way for a Fed that wants to normalise interest rates, and has been for some time, this should be a concern to Fed members.
Growth should not be the only thing tugging away at Fed members’ gradually tightening stomachs. Inflation is also not yet moving towards their 2% target. The Fed’s favourite inflation gauge, the core PCE deflator remains at 1.3% yoy with the latest 3 months of data pointing to lower yoy readings in the months ahead, not higher ones. Other indicators such as the prices paid component of the ISM release has been falling since June 2015 and is now at new lows since 2009.
The next Fed meeting is scheduled for January 27 and indicators are showing only a 10% chance of a back-to-back hike, and with no Fed meeting in February there is plenty more economic evidence to be digested by the Fed members before March 16 and their last meeting of Q1.