More from Eliott Clarke of Westpac today on why QE is dangerous road:
Each month, the ISM indexes are amongst the most watched and reported market releases. As has been the case throughout this recovery, ‘positive’ readings for both of these surveys in 2013 have sparked optimism around the outlook, irrespective of what other data may indicate. In November, the manufacturing PMI rose to 57.3, a level only surpassed in two periods during the past ten years – late 2010/early 2011, and almost a decade ago in 2004. Further, both the production and new orders indexes have risen to be comfortably above 60.
The manufacturing ISM outcomes noted above are strong relative to history. Indeed, with respect to GDP growth, ISM notes that the current level of the manufacturing composite is consistent historically with growth circa 4.7%, while the average level of the composite through 2013 corresponds with real growth of around 3.6%. Both of these growth rates are well above trend US growth, circa 2.25%, and the 2.2% average pace of growth experienced throughout the now four-year long recovery. The non-manufacturing ISM survey also saw robust gains in 2013, but these have faded, with the composite now back at long-run average levels.
The disparity between the manufacturing PMI and real GDP outcomes is difficult to justify without casting doubt over the index’s accuracy; to a lesser extent, the same can be said about the non-manufacturing ISM, with its 2013 burst to above-average levels out of kilter with the sub-trend domestic final demand growth of mid-2013. Arguably, the disparity in both sectors is being driven by two key factors: ISM respondents are typically larger firms with global exposure and comparatively strong market positions; also, the larger rise in production and activity versus employment points to a degree of spare capacity, limiting the pass through of momentum to the broader economy.
To test this thesis, it is instructive to consider the NFIB small business survey. Firms surveyed by NFIB arguably focus more on the domestic economy than export markets. Being smaller, their market position is also likely to be weaker. Cross referencing the results of this survey against the ISMs then provides a means to assess the breadth and depth of the strength reported by the headline-grabbing ISM surveys.
Starting with aggregate activity, whereas the ISM measures have generally pointed to conditions in 2013 being above average, this is not true of the NFIB ‘optimism’ composite which is well below its long-run average. Of the components, despite improving through 2013, ‘general business conditions’ and ‘outlook for expansion’ both remain well below average levels, indicative of very subdued economic conditions. Earnings are also sub-par, a function of poor volumes and margin concerns – actual prices and sales are both below average. It is little wonder then that capital expenditure and hiring plans remain soft.
Arguably, not only are these comparably smaller firms unable to benefit from global demand, but they are also finding themselves at a competitive disadvantage against larger competitors in the domestic market. As is the case with households, herein we again see a disparity in conditions across US firms, limiting aggregate momentum in the US economy to a trend pace – at best. It is also worth noting that, despite hiring plans remaining below average, actual small business employment has remained around average levels for the past two years; ergo, as for large businesses, small businesses also likely have excess capacity, limiting their need for additional staff.
Aside from the detail on activity and employment, the NFIB survey is also of use when considering smaller firms’ appetite for debt to fund expansion as well as banks’ willingness to provide the necessary funding. As at October, just 6% of respondents saw now as being a “good time to expand facilities”. It is hardly surprising then that “a record 66% expressed no interest in a loan” and that a record-low 28% of business owners reported borrowing on a regular basis. In terms of supply, a net 6% of regular borrowers saw loans as being “harder to get” compared to their last attempt, and a net 8% expect a further deterioration – a tightening in credit conditions. This is yet more evidence of QE’s very limited effectiveness in spurring activity in the real economy.
Before concluding, it is worth noting that, just as the confidence of big business is not shared by small business, it is also not shared by households. October’s fiscal malaise and higher mortgage interest rates obviously had a material impact on households, as evinced by the recent deterioration in both sentiment measures. This is despite households remaining relatively optimistic about the labour market, frequent new highs for equity markets, and the ongoing (albeit arguably frail) recovery in house prices.
The take out from this analysis is that market participants and policy makers alike would be well advised to remain cautious on the outlook for the real economy. Main Street remains under considerable pressure, limiting growth opportunities in this household centric economy.