Why We May Finally Be Able to Take the Cast Off the Economy

Source: Thinkstock

Source: Thinkstock

“When you break a leg, you don’t just snap the pieces back into place; you leave the cast on until the bone heals. Otherwise, you risk doing even greater damage. And in this case, the economy wasn’t ready to walk on its own,” John Williams, president of the Federal Reserve Bank of San Francisco, said at the end of June while explaining his reasons for why the Fed did not tighten its monetary policy in 2010. The decision to keep policy loose and interest rates low has helped stimulate the economy, but has also been criticized by many who think the Fed is over-medicating the economy.

But going by all the incoming data, we may be approaching such a time when the cast can be taken off and the Fed can actually start exiting an accommodative monetary policy by next year, as growth in the U.S services may lead the economy into a much-awaited phase of expansion sooner rather than later. Both the Institute of Supply Management’s non-manufacturing survey and Markit’s services purchasing managers’ index (PMI) indicate strong business activity in the sector for the month of June.

The Markit Services PMI rose to 61 in June from 58.1 in May, the strongest rate of growth since October 2009. All the three parameters — output, new business, and employment — have risen at the fastest rates in five years. The reading suggests that customer confidence is back and companies are firing on all cylinders to meet new demand after a long unproductive winter. The new business index was up at 60.8 in June from 58.7 in May this year, and employment numbers in the sector showed an impressive come back with the index rising up to 56.1 in June from 52.8 in May. An increase in new orders could mean more hiring, going into the third quarter.

Markit’s final composite PMI, which is a weighted average of its manufacturing and services indices, clocked in at 61.0 in June, a record high versus 58.4 in May.

According to Markit, the increase in business orders for both manufacturing and the services sector, prevailing positive investment sentiment, and a pickup in business activity could take gross domestic product growth number in the second-quarter to 4 percent. If this does happen, this would be a pretty dramatic recovery from a contraction of 2.9 percent in the first-quarter.

The ISM non-manufacturing survey, however, was a little more subdued than Markit’s PMI, as the index marginally retracted to 56 in June from 56.3 in May against a consensus of a status quo. Though the business activity index fell 4.6 percent to 57.5 percent in June, the new orders index was up 0.7 percent to 61.2 percent in June. The Employment Index increased 2 percent to 54.4 percent from the May reading of 52.4 percent. Both the numbers reinforce the findings of the PMI survey of underlying strength in demand and prospects of improvement in employment for the year.

The 14 non-manufacturing industries that reported growth in June were: construction, real estate, rental and leasing, utilities, management consultancies, arts, entertainment and recreation, agriculture, forestry, retail trade, transportation and warehousing, and scientific and technical services. The four industries that reported contraction in June were: educational services, mining, accommodation and food services, and healthcare and social assistance.

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