Will manufacturing mean lower rates and higher bond prices?
What is the Purchasing Managers Index (or PMI)?
The Purchasing Managers Manufacturing Index, (or PMI), is based on a monthly survey of selected companies that provides an advanced indication of what’s really happening in the private-sector economy. A reading above 50% indicates that the private manufacturing sector has expanded, whereas a reading below 50% indicates that private-sector manufacturing output has contracted.
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What did January’s reading indicate?
January’s PMI declined sharply by 5.2 points from December’s 56.5 level. The most significant decreases were observed in new orders, down 13.2 points to reach to 51.2, and production, which was down 6.9 points to reach to 61.7.
Both bellwether numbers indicate that consumption and private investment in the U.S. economy are off to a slow start in 2014. Part of the slowdown in manufacturing activity has been attributed to the colder weather experienced in January.
A decrease in the PMI implies that manufacturing is contracting, which is generally ahead of a decrease in consumption and business activity. If sustained, the lower consumption may lead manufacturers to reduce private investment, which would reduce the demand for credit and result in lower interest rates and higher bond prices. However, most industries in January remained in expansion. February’s reading will indicate whether this trend continues.
January’s reading, however, had several caveats. Firstly, 11 out of the 18 industries covered were in expansion. Secondly, we can’t discount the impact of adverse weather on the reading.
The bottom line is that if PMI does fall below 50 next month, investors are likely to fly to safety and buy bonds as they take money out of equity markets—just like they’ve been done throughout February. This would increase bond prices and cause interest rates to fall.
To read about the ISM’s second indicator due to release Wednesday, move on to Part 4 of this series.