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The economy and the fixed income markets: Must-know latest updates

Part 3
The economy and the fixed income markets: Must-know latest updates (Part 3 of 11)

Why new orders and business activity increased on national levels

Solid growth trajectory

Last week’s Purchasing Managers’ Index (or PMI) releases, including the manufacturing and services sectors, pointed at a spring momentum after suppressed winter data. Both manufacturing and services PMIs registered a reading of 55.5 for the month of March 2014. Any number over 50 level signals that the manufacturing and service economy is expanding. The manufacturing index’s performance was driven by higher number of new orders and modest rate of job creations, while the service index indicated a sizable increase in the business activities and higher optimism in the next 12 months’ expected overall business activity.

PMIEnlarge Graph

PMI Index

Every month, Markit Economics, a financial data collection company, surveys a panel of over 1,000 companies to track business trends across the manufacturing and service sectors in the U.S. Based on the responses, the Markit U.S. Composite Index is prepared. The composite index complements the Markit U.S. Services PMI and the Markit U.S. Manufacturing PMI. Both the indices are reported on a monthly basis.

What did latest reading indicate?

The PMI Manufacturing Index

On a composite level, the PMI manufacturing index grew to 55.5 levels, but lower than February’s growth of 57.1 levels. March data indicated that the overall index was supported by sharp rises in output (57.5) and new business (58.0). Manufacturers noted that higher levels of output reflected rising volumes of new work and ongoing efforts to reduce backlog accumulation at their plants. A backlog of work was reduced to 54.8 levels from 57.9 levels in January, 2014.

A modest rate of job creation was sustained across the manufacturing sector in March at 53.9 levels compared to 54.1 in February 2014. Supplier delivery times increased to 47.5 from 40.6, but still remain below the 50.0 level thresholds.

Few offsetting indicators were the subdued export demand at 51.0 compared to 51.6 in February 2014, and higher cost burdens, which led to the rise in factory gate prices during March 2014, at 54.6 compared to 54.1 levels in February 2014.

The PMI Service Index

At 55.5 levels in March 2014, the headline seasonally adjusted Markit Flash U.S. Services PMI Activity Index picked up sharply from February’s four-month low (53.3). However, the new order growth and outstanding business contracted, spilling weather-related disruptions. The outstanding business (meaning work is already in backlog or in progress) index declined to 48.3 levels from 50.9 levels in February 2014. Much of the backlog decline was due to slow growth in the new orders, which ended March 2014, at 53.9 from 56.0 in February 2014.

Service employment levels was essentially unchanged, however, cost inflation declined, meaning that the companies charged higher price for the services provided than what it cost to deliver a service (normally referred as input cost).

Market reactions

The buoyancy in the U.S. manufacturing data encourages firms to expand and hire new staff. Further, rise in the output at an annualized 4% in the first quarter and steady job creation in the sector, will no doubt add weight on the Fed’s continuation of its monetary policy. Furthermore, the Fed’s chairwoman, Janet Yellen also indicated in her speech on March 19, 2014, that the Fed will continue the taper as scheduled and also provided an indication that the first interest rate hike may come nearly six months after tapering concludes. Tapering is expected to conclude by October or November, 2014. With the indication of a rise in interest rate earlier than expected, Treasury yields across the maturity rose, putting a downward pressure on the bond prices.

Major ETFs that reflect the performance of the bond and stock market with change in the nation’s manufacturing and service activities include the SPDR S&P 500 (SPY) ETF, with investments in 500 largest U.S. firms including names like Apple (AAPL), Exxon Mobil (XOM), and General Electric (GE). The fund seeks the performance of the large capitalization sector of the U.S. equity market and is considered one of the best representations of the domestic stock market.

The Total Bond Market ETF (BND) which measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the U.S.

Another major indicator released this week on which the market reacted sharply is the Retail Sales Index. The index is also a barometer to gauge the consumer spending level. A decline in the spending suggests bearish investor sentiment on the growth of the economy, while the opposite holds true for an increase in the consumer spending. Read Part 4 for further information.

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