The Daily Economic News Report - Tuesday, July 02, 1996

T H E M O T L E Y F O O L ' S
The Daily Economic News Report
Tuesday, July 02, 1996

A few weeks ago, when the yield on the 30-year T-bond was hitting new short-term highs around the 7.20 percent level, it looked like the whole world was convinced that galloping inflation, if not already here, was just around the corner. At the time, I just couldn't see the basis for all the fear. Obviously, the CPI, the PPI and all of the various price deflators were not showing any signs of taking off. Moreover, gold prices, capacity utilization, the producer price index for intermediate goods, unit labor costs, and the exchange rate of the dollar -- all leading indicators of inflation -- were showing no signs of inflationary pressure. In fact, the upsurge in interest rates seemed to be slowing down the economy. This was especially evident in the pick up in new claims for unemployment insurance and in the slowdown in the housing sector. I said to myself, "Merlin, here's a chance for you to look really clever on July 1, when you inform the world that all of these people are wrong, that inflation is not imminent and that the Fed will leave interest rates unchanged when it meets the following day."

Well it looks like, between then and now, almost everybody else has come around to my way of thinking. Maybe they've all been reading my column and were convinced by my arguments. In a poll conducted by Reuters the other day, 26 out of 34 economists said they expected the Fed to leave interest rates unchanged tomorrow. Even the worry-wart bond traders seem to be feeling more optimistic. In the past few weeks the long bond yield has come all the way back down to 6.90 percent. What's more, all the gloomsters who drove the stock market down eight consecutive days a couple weeks ago merrily drove the Dow Jones Industrial Average up by 75.35 points today.

Oh well, at least I can say, "See. What did I tell you?"

The markets seem to have become adjusted to the idea that we may be able to have an economic expansion without inflation getting out of hand. Perhaps that's why the bond market only sold off slightly after today's upbeat report by the National Association of Purchasing Management report on the results of its June member survey. Today's report was the best report of its kind in almost a year and a half.

From May to June, the Association's Purchasing Manager's Index (PMI) rose from 49.3 to 54.3, the highest reading in 16 months. The PMI is a composite of five different indicators measured by the survey (New Orders, Production, Supplier Deliveries, Inventories, and Employment). In theory, the PMI can vary anywhere between 0 and 100. But, in practice, the Index has moved in a range between a high of 78 in 1950 and a low of 30 in 1980. During the past 5 years it hit a low of 38 in 1991 and a high near 60 in October, 1994. Any reading less than 50 is indicative of weakness in the manufacturing sector. So, the May reading of 54.3 indicates that the manufacturing sector is at long last beginning to show some signs of life.

As might be expected, the individual components that make up the PMI also rose. The employment index increased from 45.5 to 49.4, a sixteen-month high. The supplier delivery index also rose from 50.0 to 53.2. This index rises as supplier deliveries slow, because slower deliveries are indicative of increased manufacturing activity.

Production, new orders, and order backlogs all grew, and inventories shrank -- all signs of an increased level of activity.

In spite of all this, the NAPM prices-paid index decreased slightly from May to June, dropping from 50.5 to 49.0. This signifies that slightly fewer purchasing managers were paying more for raw materials than were not. Thus, during June, raw materials inflation was flat while orders and output increased.

Summing up: For the time being, the economic environment is one of moderate economic expansion coupled with a modest, controlled, level of inflation. What's more there is little sign of higher inflation in the foreseeable future. Let's hope that the Fed is successful in maintaining this environment.

Byline: Lafferty (MF Merlin)