Must-know: Why did firms report a sharp spike in wages in May?

Phalguni Soni - Author

Aug. 18 2020, Updated 6:13 a.m. ET

The Richmond Fed’s Survey of Fifth District manufacturing activity maintains growth levels in May

Each month, the Richmond Fed releases its manufacturing survey based on the survey readings of approximately 100 respondents whose firm type, firm size, and location collectively match the profile of overall manufacturing in the Fifth District. The Fifth District includes businesses in Washington, DC, Maryland, North Carolina, South Carolina, Virginia, and most of West Virginia.

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The Richmond Fed announced the results of May’s survey on Tuesday, May 27. The composite index reading came in at seven, unchanged from last month and slightly below market estimates, which had expected a reading of nine. A reading above zero implies expansion and an increase in activity, while a reading below zero implies the opposite.

The best-performing components of the composite were employment indicators, order backlogs, and shipments. Firms also reported wage increases in May, with the wages component spiking to 22—its highest level since July 2000. New orders volumes, capacity utilization, and finished goods inventories recorded a decline.

About the Richmond Fed’s Survey of Fifth District Manufacturing Activity

This is a monthly survey conducted by the Federal Reserve Bank of Richmond. Respondents provide information on current activity, including shipments, new orders, order backlogs, and inventories and also provide feedback with respect to business expectations over the next six months. The headline number is the composite index for the current month’s activity. It’s a weighted average of the shipments (33%), new orders (40%), and employment (27%) indexes (source: Federal Reserve Bank of Richmond).

Key takeaways from May’s reading: Firms upbeat over business conditions

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Manufacturing growth appears to be steady in the Fifth District. Although new orders declined sharply month-on-month, firms remained upbeat for business prospects over the next six months. Survey respondents expected growth in new orders and capital spending over the next six months, which would imply a favorable outlook for manufacturing output for the rest of the year.

Inflationary trends: Wages spike sharply

Wage pressures accelerated in May, according to the survey. The average wage index rose by 16 points over March to 22, its highest reading since July 2000. While this sudden spike may be a one-off phenomenon, other inflationary indicators were also apparent.

Inflationary trends: Firms reluctant to pass on cost increases to customers

Raw material prices shot up to a 1.36% annualized rate, compared to only 0.78% in April. Finished goods prices rose too, coming in at an annualized rate of 0.56% compared to 0.30% in April. Firms expect input prices to rise at an annualized rate of 1.69% over the next six months, while selling prices are expected to rise more moderately, at an annualized rate of 1.01%. This may imply that firms are yet uncertain of the demand environment and fear a potential loss of sales due to competitive pressures.

Employment gains surface

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Employment in the manufacturing sector grew in May, with the employment index rising six points to ten. The average workweek grew slightly too, which corroborated signs of a recovery in the labor market. To read about April’s way-better-than-expected rebound in the labor market, please read the Market Realist series Why April 2014 saw the best payroll numbers since January 2012.  

Investor impact

Increases or decreases in manufacturing activity would impact companies in the industrials space. The Vanguard Industrials ETF (VIS) invests in the stocks of large, medium, and small U.S. companies in the industrials sector in the aerospace and defense, construction, and logistics spaces. The top ten holdings in VIS include Danaher Corporation (DHR) and Honeywell (HON).

Although, normally, interest rates would rise when the economy is in expansionary mode, fixed income markets have responded to the more immediate demand considerations for safe-haven securities. Pension funds are also keen to match their long-term liability stream with longer-term assets like U.S. Treasuries. Rates for debt securities have fallen and ETFs investing in fixed income securities like the Vanguard Total Bond Market ETF (BND) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) have returned 2.67% and 3.07%, respectively, year-to-date (as of May 16).

In the next part of this series, we’ll discuss the Conference Board’s consumer confidence report for May. Please read on.


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