ADP, or Automatic Data Processing, predicts 230,000 private payroll jobs could be created in September per tomorrow’s U.S. unemployment report. The reason is both the manufacturing and non-manufacturing (service) sectors reported strong hiring in their ISM indexes, which are surveys of supply managers in those industries, and where indexes above 50 indicate expansion in their sectors.
Led by a record high in employment and a 14-year high in business activity, the Institute for Supply Management’s non-manufacturing index of business activity jumped 4.5 points to 65.2. This is one of four components of the composite with the others also consistent with acceleration: new orders up 1.2 points to 61.6, supplier deliveries lengthening by 1.0 point to 57.0, and employment up 5.7 points to 62.4 in a reading. It is the strongest result yet for the composite which was established in 2008, said Econoday.
And an exceptionally strong ISM manufacturing index came in at 59.8 for September. New orders slowed more than 3 points but remain very strong, at 61.8 and with export orders also strong at 56.0.
“Comments from the panel reflect continued expanding business strength,” said Timothy R. Fiore, Chair of the Institute for Supply Management® (ISM®) Manufacturing Business Survey Committee. “Demand remains strong, with the New Orders Index at 60 percent or above for the 17th straight month, and the Customers’ Inventories Index remaining low. The Backlog of Orders Index continued to expand, but at lower levels compared to the previous month. Consumption improved, with production and employment continuing to expand, at higher levels compared to August, despite shortages in labor and materials.”
Also good news was the continuing expansion in factory orders, up 2.3 percent; though mostly in durable goods such as aircraft, motor vehicles and ships. Commercial aircraft orders surged 69 percent with defense aircraft up 17 percent. But excluding these as well as a jump in ships & boats and a 1.0 percent rise in motor vehicles, factory orders in August managed only a 0.1 percent gain, said the report.
The question becomes will this strong demand and consequent economic growth continue? Fed Chairman Jerome Powell said it can continue for several years. But he also said the Fed is on track to continue raising interest rates through next year, at least. Powell said the U.S. central bank wants to raise rates to a “neutral” level that neither boosts nor restrains growth. The level of short-term rates is still far away from neutral, he said at a recent Atlantic Magazine conference.
But what, exactly, is a “neutral” rate? The benchmark for most fixed rates is the 10-year bond yield, now at 3.19 percent and rising. In the aftermath of the Great Recession it only dropped below 3 percent with the Fed’s quantitative easing programs that purchased mortgage-backed and Treasury securities.
This means interest rates could rise another one percent now that the Fed has ceased QE and is selling those securities back into the markets. Higher rates could slow housing sales with the 30-year conforming fixed rate already at 4.375 to 4.75 percent for a one point origination fee in California. Housing sales have already slowed with fewer entry-level homes being built, so that California has a one million unit housing shortfall.
A “neutral” interest rate is the rate at which the supply and demand for goods and services is in balance, which also means a top in the markets from which GDP growth will ultimately slow. That may seem common sense, but in fact the Fed has historically stopped raising their rates only when bear markets and recessions have begun.
I agree with the Fed Chair that short-term rates are still below neutral, but no more than perhaps one percent, as I said. So look for 3 to 4 more Fed rate increases before we ‘crest’ this business cycle and begin the inevitable downturn.
Harlan Green © 2018
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