Chicago PMI reflects red-hot manufacturing sector

As the recovery begins to broaden, manufacturers, which helped to stabilize and pull the economy out of the worst recession since the 1930s, continue to expand at an ever-quickening pace, at least according to the Chicago Purchasing Managers’ survey.

The Chicago PMI, increased from 68.8 in December to 71.2 in January, the highest reading since July 1988.  A reading of 50 suggests manufacturing is neither expanding nor contracting.



Even better, new orders – a proxy for future activity – edged up from 75.7 to 75.9, the best reading since December 1983!  Meanwhile, production grew by 5.5 points to the torrid pace of 78.2, and employment, which eased from a 27-year high, remained favorable.

However, the fast-paced expansion in manufacturing has not been without some problems, as growth continues to boost prices at the early stages of production and crimp profit margins.

The Chicago PMI, which looks at manufacturing in the Midwest, tends to be a bit more volatile than the closely-followed ISM Manufacturing Index, which measures production on a national level.

Still, a reading of over 70 is loudly suggesting that manufacturing is firing on all cylinders, and components within the index are signaling the all-clear sign in the short term.

Pending home sales slip–weather may have played a role

Those hoping the new year might provide a boost to the fledgling housing market were disappointed by the latest data released by the National Association of Realtors. However, let’s not make too much out of the decline since rough weather in parts of the country may have skewed the data.

The Pending Home Sales Index declined by 2.8% to 88.9 based on contracts signed for existing homes in January from a downwardly revised 91.5 in December.



Lawrence Yun, NAR chief economist, points to the broader trend. “The housing market is healing with sales fluctuating at times, depending on the flow of distressed properties coming on the market,” he said.

“While home buyers over the past two years have been exceptionally successful with historically low default rates, there is still an elevated level of shadow inventory of distressed homes from past lending mistakes that need to go through the system,” Yun said. “We should not expect the recovery to be in a straight upward path – it will zig-zag at times.”

He continued to point to favorable tailwinds for the market, including job growth, the high level of affordability, rising rents and even talk that some buyers may be looking to real estate as a hedge against potential future inflation.

In my view, his comment that the market is starting to heal but the recovery is unlikely to be a straight upward path makes sense.

But I believe he is putting too much stock is job growth, rising rents and inflation talk.

At this point in the housing cycle, the high level of unemployment and uncertainty over prices remains a huge stumbling block to an eventual foundation that’s needed under the market.

And mortgage rates that fell to almost 4% on a 30-year fixed rate did little to support sales amid the uncertainty swirling around housing.

At best, the market has shaken off the downward spiral caused by the expiration of the tax credit. Eliminate the government incentive and the chart above suggests sales have been flat for about two years.

One caveat: As any realtor knows, nasty weather such as snow, blizzards and rain will keep buyers inside, which potentially delayed some signings.

We’ll need to look at February and March to get a clearer pictures of what’s going on.

New home sales meander along the bottom

Weak builder sentiment continues to be reflected in a very poor market for new homes, as evidenced by the release of yesterday’s dismal report.

The U.S. Commerce Department announced that new home sales in January fell a much worse-than-expected 12.6% to a a seasonally adjusted annual rate of 284,000 units. 

That pushed the supply of homes (based on current sales) from 7.0 months to 7.9 months, while the actual number of homes for sales fell by 1,000 to 188,000, the lowest since late 1967. But it's the large decline in sales over the last five or so years that is masking the big slide in the actual number of home for sales; hence, the 7.9 months supply available is actually a bit on the high side even as the number of houses for sale is the lowest in over 40 years.



Since weather did not appear to play much of a role in existing home sales last month, it seems safe to say that the large drop that greeted the new year is probably not weather related, though we’ll need to review the data in February and March to confirm.



Not surprisingly, the huge drop in sales from the 2005 peak (see first chart) has been matched by a stunning drop in inventory of homes available (see second chart). 

Typically, a large reduction in inventory in a manufacturing operation sets the stage for a rebound in production. Housing, however, is different animal for a number of reasons.

And the shadow inventory that exists from late-model homes that are either in foreclosure or near foreclosure is providing stiff competition to builders and is offering skittish buyers that are willing to tiptoe into the market plenty of options. 

Low mortgage rates may be helping at the margin, but the incredible amount of uncertainty in the housing market has prevented cheap financing from having much of a favorable impact.

Until we see a decent jump in job creation, coupled with a turnaround in the already-discussed factors that are hindering the market, sales are likely to mope along the bottom.

Weekly jobless claims back below 400,000

Weekly initial jobless claims fell 21,000 in the latest week to 391,000, and the 4-week moving average, which removes much of the volatility from the seven-day number, dipped 16,500 to 402,000.

With weather receding as a factor that has caused all kinds of distortions with the data, the downward trend is providing a reassuring vote of confidence that the pace of the recovery is quickening.

Existing home sales stabilize

Existing home sales increased 2.7% to a seasonally adjusted annual rate of 5.36 million in January from a downwardly revised 5.22 million in December, and are 5.3% above the 5.09 million level in January 2010.

This is the first time in seven months that sales activity was higher than a year earlier, according to data supplied by the National Association of Realtors.

In another sign that the market is beginning to heal, housing inventory fell 5.1% to 3.38 million existing homes available for sale, which represents a 7.6-month supply at the current sales pace, down from an 8.2-month supply in December.

Last year’s peak in inventory occurred in August at a level of 4.1 million units, which represented a supply of 11.7 months.



NAR chief economist Lawrence Yun said the improvement is good but could be better. “The uptrend in home sales is consistent with improvements in the economy and jobs, which are helping boost consumer confidence,” Yun said.

“The extremely favorable housing affordability conditions are a big factor, but buyers have been constrained by unnecessarily tight credit. As a result, there are abnormally high levels of all-cash purchases, along with rising investor activity.”

I might add that sluggish job growth and the uncertainty surrounding where home prices are headed are also depressing demand.

Despite indications that sales are slowly improving, the rising number of distressed sales  (37% of the market in January), along with high levels of all-cash purchases (28% last year), continue to depress housing prices, which are down 3.7% from one-year ago to a median price of $158,800, the lowest in nearly nine years.

Meanwhile, indications that sales of existing homes are beginning to stabilize or even slowly improve are being called into question by the NAR’s decision to review data going back to as far as 2007, according to the Wall Street Journal and several other news agencies.

The data are being looked at to determine whether revisions are necessary, with a decision expected by the summer. Economists have raised concerns about the NAR's data, saying sales may be overstated by as much as 20%, the Journal said.

"I don't know what that revision will be," Yun told reporters at a briefing to discuss the January data.

"But most indicators imply that NAR data probably has some upward drift," he said, noting that the last re-benchmarking in 2000 showed that the group's sales estimates were overstated by about 13%.

Though recent trends are more important and paint a picture of what’s happening right now, a downward restatement would show that the housing debacle over the last few years was worse than previously thought and could call into question the reliability of data gathering techniques used by the realtor-based organization.

Consumer confidence at three-year high

In a day where much of the focus has been on the violence in Libya and its impact on oil prices, the Conference Board released its monthly survey and provided another piece of the economic puzzle showing that the rising tide of economic activity is lifting spirits.

The Consumer Confidence Index jumped from 64.8 in January to 70.4 in February, well above the stagnant range its been in since the summer of 2009 and the best reading in three years.



Lynn Franco, Director of The Conference Board Consumer Research Center, cited “growing optimism about the short-term future,” but also cautioned that labor market conditions may have improved moderately, but they "still remain rather weak."

Rising consumer confidence is likely to lend more support to consumer spending, which accounts for 70% of the U.S. economy.  Further gains in spending would fuel additional activity and help to put the recovery on a self-sustaining path.

But meaningful increases in employment are what’s needed in order to get consumer confidence back to pre-recession levels and revive sectors of the economy, such as housing, that continue to lag.

Headline CPI up but core inflation remains muted

The Consumer Price Index rose 0.4% for the second straight month, as higher energy and food prices lifted the headline number. Core inflation, which strips out the more volatile food and energy categories, remained under control, rising 0.2% in January.

Though modest, the rise in the core rate was the fastest increase in 15 months according to data supplied by the BLS.



As expected, energy was among the big gainers, with prices rising 2.1% in January.  Gasoline posted a 3.5% rise.

Food costs, which have remained under control at the retail level, are now beginning to react to the steep rise in agricultural commodities, as prices rose 0.5%.

Apparel prices also jumped but housing/shelter barely increased.

Year-over-year, the CPI is now up 1.6%, versus 1.5% last month, while the core rate of inflation, which the Fed keeps a closer eye on, rose from 0.8% y/y to 1.0% y/y.

Looking at the chart above, the core rate of inflation has likely bottomed given the continued rise in commodity prices and the broadening economic recovery. But at just 1.0%, it remains well below the comfort level of policymakers at the Fed.

I suspect that in the short-term, the forces keeping a lid on inflation, including the slack in the economy, reasonably-well anchored inflation expectations (that’s a big one) and minor wage increases, will more than counter the significant rise in raw material prices and excess liquidity being pumped into the economy by the Fed.

And the very low level of core inflation makes it much easier for the Fed to maintain its planned purchases of $600 billion in longer-term government securities, especially since growth in nonfarm payrolls has been extremely lackluster.

What the Fed must do is implement an exit strategy that does not wreck the still-delicate but broadening recovery while not waiting too long, which might make it difficult to contain inflation at the retail level.

The Fed has insisted on many occasions that it has the means and ability to remove the excess stimulus without threatening price stability.  However, the Fed has typically remained on the accelerator for too long in past cycles.

A second option – hefty anti-inflation rhetoric at the appropriate time – might also be part of its arsenal of weapons, as it hopes to contain any potential rise in inflation expectations.

One thing appears to be certain, the best news on inflation is very likely behind us, as the core rate appears to have bottomed in October at 0.6% y/y.