US PMI numbers point to robust growth and receding inflationary pressures

Strong PMI numbers from the US today, with all three measures printing above the key 50.0 level to signal a US economy that continued to expand as we moved into 2024. The overall composite reading rose from 50.9 to 52.3, signalling the fastest pace of expansion in economic activity since June 2023, this increase driven largely by a strong performance in the services sector. The picture for manufacturing was more mixed, as a moderate decline in output was reported but offset by a further, broad based, increase in new orders, which have now risen for three months in a row. But an overall manufacturing PMI of 50.3 was sufficient to show factory activity overall expanding, for the first time since April 2023.

Clear in today's report is that the main driver of this improving outlook is domestic in nature, as evidenced by new export orders falling for the second month in a row, a picture that ties in with the continued strength being seen in the retail sales numbers. The strength of this consumption is being translated into improving business optimism, which has risen to its highest level since May 2022, and with respondents anticipating improving demand conditions going forward, increased capital investment and the release of new service lines.

This improving economic picture, however, is not translating into significantly stronger labour demand, with the employment components showing their second-softest readings since August 2023 to post only marginal increases overall. But crucially, from the perspective of a US Federal Reserve (Fed) that remains concerned about the potential for wages growth to sustain inflationary pressures, there are no material signs yet of any actual weakening in the labour market.

More positively, inflationary pressures continue to show signs of easing, input prices rising at their second slowest pace since October 2020. But within this overall softening story, the underlying picture is one of sectoral divergence. Manufacturing input cost inflation was reported as rising at its fastest pace since last April, amid growing supply chain issues and higher transportation and energy costs, and culminating in factory gate prices rising at their fastest pace over this same period; services providers, in contrast, signalled the slowest rise in output prices since June 2020. However, overall, average prices charged for goods and services rose at the slowest rate since May 2020, and key for the Fed will be that it was primarily the services sector that was largely responsible for this downshift, given its focus on core services when assessing the strength of underlying inflationary pressures.

Overall, today’s report will add to the pressure on the Fed to drop its message that a further interest rate rise continues to remain on the table; the market no longer believes this message and the Fed risks an erosion in its credibility while it continues to maintain it. However, this does not mean that it will necessarily be prepared to signal an easing in interest rates any time soon; it will be concerned that supply chain disruptions were reported to be intensifying and that labour market conditions remain tight. As such – and subject to next week’s PCE numbers – the immediate outlook looks set to be a continuation of the ‘wait and see’ approach, the Fed continuing to monitor cost pressures closely and desisting from any relaxation in monetary policy until it is definitively certain that CPI is heading back to target. Consequently, even thought today’s report, on its own, showed inflationary pressures rising at their slowest pace since before the Covid pandemic, the dial has probably moved a little towards a first interest rate cut coming in May rather than March.