A BIAS FOR GROWTH…SORT OF

The Institute for Supply Management publishes indices that are widely followed on Wall Street. Two in particular receive quite a bit of attention. Both were updated in recent days, and both offer conflicting signs for the economy.
The ISM Manufacturing Index for January was released last week and its message is anything but upbeat. As our chart below illustrates, this measure of manufacturing has fallen to its lowest in nearly four years. What’s more, the downward bias has been intact for a year or so, suggesting that the weakness is more than a temporary blip. Readings below 50 indicate that manufacturing activity generally is contracting, and so January’s reading of 49.3 is nothing if not clear.
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But don’t give up hope just yet. The ISM Services index offers a cheery counterpoint to manufacturing. The non-manufacturing index, as it’s known, climbed to 59 in January, the highest since last May. Returning to the chart above, it’s obvious that the rise in this measure of the services piece of the economy has been expanding at an accelerating clip since last fall.
Although our graph suggests the two indices are equal, in fact they could hardly be less so. Manufacturing is but a minor share of the American economy in the 21st century. The lion’s share of the nation’s business is now in services. If one of the indices has to turn down, manufacturing’s descent will presumably have less negative influence on the general direction of the economy.
“The real strength in the economy is the service sectors and they do not seem to be dragged down in any way by the housing and auto sectors,” Nigel Gault, chief economist for Global Insight Inc., told Bloomberg News yesterday.
But the bond market isn’t quite so sure. A bullish outlook on the economy usually spells trouble for bonds, i.e., higher yields. So far in February, however, the yield on the 10-year Treasury has shown a penchant for falling. Yesterday, the 10-year closed at roughly 4.81%, down from nearly 4.90% last week.
In fact, the ISM Services index may be less than it appears, suggested David Resler, chief economist at Nomura Securities in New York, in a note he wrote to clients yesterday. For instance, “several indices of key dimensions of activity — including orders, inventories, export orders and employment — showed signs of deterioration,” he explained.
All of this can be said to be favoring a sweet spot for the Federal Reserve’s monetary policy. Growth that’s modest keeps optimism bubbling but without inflationary fears. The fact that the pessimists and optimists continue to argue suggests that something approaching a middling outlook remains probable for 2007.
Indeed, trading in Fed funds futures contracts continues to anticipate a Federal Reserve that keeps interest rates steady through the summer. Not too hot, not too cold is still the mantra, and there’s fresh data to expect no less.

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