Business Activity Is Up; Did the Fed Get It Right This Time?

Source: Thinkstock

Source: Thinkstock

The results of the various regional business activity surveys for July are likely to make the Federal Reserve ecstatic. Business activity has picked up pace and is touching multi-year highs. The number of new orders is rising and employment is upward bound. Price pressures are building up as well. However, some of the regional surveys are showing dimmed view of the future in terms of sustained increases in these parameters for the next six months to a year.

According to the Federal Reserve Bank of Philadelphia’s Business Outlook Survey for July, the diffusion index of current general activity in the region increased from a reading of 17.8 in June to 23.9 this month. The index has remained positive for five consecutive months and is at its highest reading since March 2011. When majority of the parameters show positive growth, the diffusion index tends to be positive, and vice versa.

The index for current new orders increased 17 points in July to 34.2 and shipments increased 19 points to 34.2, according to the Philadelphia Fed survey. Unfilled orders remained positive at around 10 points, but the index was lower than 11.5 in July, which indicates higher capacity utilization by firms.

The pick up in business activity has come as a major boost for the labor markets. In June, the total unemployment rate unexpectedly fell to 6.1 percent and the economy added 288,000 jobs. The gains in the labor markets can be seen across multiple regions as well. The percentage of firms reporting increases in employment (24 percent) much exceeded the percentage reporting decreases (12 percent), according to the Philadelphia Fed survey. The workweek index increased 5 points, having been positive for the fifth consecutive month.

The general level of the prices of goods is a good indicator of potential demand in the economy and helps monetary policy makers gauge the underlying strength of economic growth. This means that softness in prices is a sign of the economy running below its full potential, something that has been of utmost concern for the Federal Reserve since last quarter. But now that picture is slowly changing, though the increases are incremental.

In the Philly survey, about 36 percent of the firms reported higher input prices this month. The prices received index, which reflects firms’ own final goods prices, increased slightly, from 14.1 to 16.8. The percent of firms reporting higher prices (21 percent) was bigger than the percentage reporting lower prices (4 percent). But 72 percent of the firms reported steady prices. According to another regional survey, the Empire State Manufacturing Survey (ESMS) for the state of New York, the prices paid index rose eight points to 25.0, and the prices received index inched up three points to 6.8 in July.

Even the other business activity indicators on the Empire State survey show similar growth trends as the Philadelphia Fed survey. According to Empire State business survey, the headline general business conditions index climbed six points to 25.6, its highest level in more than four years. The shipments index rose nine points to 23.6 and new orders index was unchanged from last month at 18.8, both indexes were at their highest since early 2010. The unfilled orders index fell six points to -6.8, as companies are rushing to catch up with demand after a long latent winter period. The index for number of employees, according to the Empire State survey, climbed an impressive six points to 17.0 from 10.5 in June.

However, the indicators of future performance on both these surveys show marked deviation. This may be the result of fear among some firms that, if prices stabilize and economic growth comes back on its expected trajectory, the Federal Reserve may begin tightening its monetary policy sooner than later and squeeze systemic liquidity, or availability of funds.

The Federal Reserve in its June monetary policy statement has clearly said that it would embark on policy normalization by 2015 and start raising the benchmark federal funds rate once the labor markets have shown sustainable improvement and inflation trails in the range of about 2 percent or above. The Fed will taper off its bonds purchase program or large scale asset purchase program by October this year.

The index for future general business conditions on the Empire State survey fell 11 points to 28.5. Future new orders index dropped substantial 19 points to 25.6 points and future shipments index fell 21 points to 24.6 in July from June. But the Philadelphia Fed’s Business Outlook Survey projects economic activity will remain robust. The future general activity index on the survey increased 6 points and is at its highest reading since last October. The index has increased for three consecutive months now. The future shipments index is up from 48 points in June to 57.9 points in July.

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