Inventory pile underscores risk Philly Fed could go the Empire State way

August 20, 2015

Obama visits General Electric in Schenectady New York

“Nothing to see here, folks” was the reaction most analysts had to a completely shocking report earlier this week that showed manufacturing business conditions in New York State deteriorated at their fastest pace since the start of the financial crisis.

Economists went on to dispel concerns after the the Federal Reserve Bank of New York’s Empire State Index unexpectedly plunged almost 20 points to -14.92 that any similar weakness might turn up in the more closely-watched Philadelphia Fed data, due later on Thursday.


These analysts also said such weakness was unlikely to show in the wider national ISM purchasing managers’ index, despite the fact it too has been in a lull in recent months, saying such regional surveys tend to be volatile and disparate.

One likely explanation is that for those still clinging to forecasts that the Fed will raise interest rates for the first time in nearly a decade next month, a sharp slowdown in manufacturing is an irritant which might lead to yet another reassessment of an already-delayed forecast.

At first blush, their reluctance to get concerned about such a sharp fall in the Empire State Index may seem warranted.

But the two surveys are similar in many ways. To start, they are based on deliberately similar methodologies employed by both regional Fed banks, they pose the same main question to manufacturers about overall business conditions and they represent a similar cross-section of industry.

So unless there was a major problem with the sample or a one-off large plant closure to explain the weakness in New York, there is good reason to believe there is at least a risk these two surveys might reflect a similar mood over the same timeframe.

Lou Crandall, economist at Wrightson ICAP, notes:

The weakness in the Empire State factory survey on Monday raises the stakes a little with respect to today’s Philadelphia Fed report … We think the Philadelphia Index is likely to improve slightly in August after a sluggish performance in July.

Crandall forecasts a rise in the Philadelphia Fed Index to 8.0 from 5.7, slightly above the Reuters median forecast of 7.0 which was taken before the Empire State Index was published.

Philly Fed

Crandall continues:

However, given the disappointing Empire State data released earlier this week, we’ll pay attention to any shortfalls in the Philadelphia results. The Empire State headline index fell 19 points to -14.9, and the ISM-equivalent index fell five points to 45.1. Those were the lowest readings for those series since 2009. Anything remotely similar in the Philadelphia report would force us to revise our forecast for the national ISM index down from our current projection of 53.0.

Expectations around Monday’s Empire Index was for a rise to 5.0, but the actual number missed the lowest forecast in a Reuters survey by the largest margin in over a decade of polling on this indicator.

Even the most accurate forecaster on U.S. economic surveys in recent years, Jim O’Sullivan at High Frequency Economics, was off target by about 19 points on the index — a huge miss considering his track record.

Much of that shock was due to a significant drawdown of inventory by manufacturers and a sharp fall in new orders signalling weak demand. Readings for those two sub-indexes were -17.3 and -15.7 respectively.

Deutsche Bank’s U.S. economists wrote:

The Philadelphia Fed Index is likely to remain subdued in August. For one, the inventory increase over the first half of the year was a massive $222.8 billion, which was the highest two-quarter inventory build on record.

Last month’s Philadelphia Fed Index also showed a sharp drawdown in inventories, which partly explained why it missed consensus by such a large margin last time – 5.7 against expectations for 12.0.

This probably is the best explanation, too, for why the latest Empire State Index revealed woeful current conditions for manufacturers but relatively stable optimism about the future.

Another worry is the strengthening U.S. dollar, on an historic and almost unbroken rally since last summer that has eroded U.S. exporting manufacturers’ global competitiveness by making their products more expensive abroad.

If all of that is still not a matter for concern, there is the fact the Philly Fed has missed the Reuters consensus on the downside more often than not in over 15 years of polling.


So while there is a weak statistical correlation between both surveys, not to mention that the New York survey includes about 100 manufacturers compared with 150 for the Philly Fed, it might be worth being on guard for disappointment.

The most accurate forecaster on Empire State, Commerzbank, has a forecast of 5 penciled in for Thursday’s Philly Fed data, relatively weak considering the index’s 15.2-point reading only two months ago.

Joshua Shapiro at MFR wrote:

The only reason the Empire Index interests markets is that it is seen as a precursor to moves in the Philadelphia Fed Index for the month, which itself is viewed as a leading indicator of the ISM manufacturing index. Sometimes this works, sometimes it does not. Moreover, even when these indices move in the same direction in a given month, the relative magnitude of the changes often varies greatly.

– with additional reporting by Sumanta Dey

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