ISM Manufacturing & Treasury Yields
The first business day of June brought the arrival of the much watched U.S. ISM Manufacturing Index (Figure 1) reading for the month of May. Unfortunately, the number was corrected twice today since the initial reading was released at 10 a.m. The research team at Stone & McCarthy, specifically economist Kenneth Kim, found the error in which the seasonal adjustment for April was utilized rather than the seasonal adjustment for May.
- April’s reading was 54.9, the highest for 2014
- Consensus estimates were 55.5 for the May report released this morning.
- At 10 a.m., May ISM Manufacturing reported at a disappointing, below consensus 53.2
- About an hour later, the Institute for Supply Management initially corrected the figure to 56.0
- Shortly after noon on the East Coast, a second correction lowered the May ISM to 55.4 – the correct and final reading
May’s 55.4 reading is the highest for 2014 and consistent with other recently released economic data, which provides me with evidence that the FOMC will continue its current taper path and embark on an initial interest rate hike 12 to 15 months from now.
The report’s composition signaled strength as well. In particular, respondents cited strong demand and rising prices for raw materials, which counters the premise that deflation is permeating domestically once again.
- Prices paid rose to 60.0 from 56.5 in April
- New orders rose to 56.9 from 55.1 in April while inventories were unchanged at 53.0.
- This places the “new orders to inventories” ratio at +3.9, better than last month’s +2.1
- Employment fell from April’s 54.7 to 52.8
Keep your eyes on U.S. Treasury yields in the next few days/weeks….
Many, including myself, are fascinated by the performance of global bonds, which are off to their best start to a year in well over a decade. Since 2014 got underway, the U.S. 10-year Treasury yield has shaved 50 basis points, its quickest pace since 1995.
I attribute much of the surprising performance to the overwhelming consensus being shaken out of their view that yields would continue to climb toward 3.25%. I have argued in the past few weeks that “behavioral finance” has more to do with the decline in yields than growth and economic fundamentals.
To that point, last week’s commitment of traders report exhibited that hedge funds and large speculators reduced net short positions in 10-year note futures by the largest amount since February. Additionally, primary dealers, which were net short at the end of the first quarter for the first time in three years have now reversed and are long again.
This Thursday, I expect the ECB will bring its full arsenal to counter deflationary pressures in Europe. The Bank of Japan is committed to doing the same. I do not share the deflationary concerns of others who suggest the decline in Treasury yields portends a new round of persistent deflation. For me, it is largely the mere premise that the “crowd” is generally rarely correct and able to profit at the same time. Instead a shakeout must first occur to eliminate the positioning. Ultimately, the thesis can be correct but history teaches that it is a minority that has the ability to actually profit from it.
Keep your eyes on the U.S. Treasury market in the coming days and weeks. At 10 a.m. when the incorrect ISM reading was reported at 53.2, it was very surprising that the U.S. 10-year Treasury yield actually rose; it should have traded even lower. It might just be that enough of the consensus crowd has been shaken out of their position; surely some of the recent positioning reports suggest that.
The next 25 to 30 basis points in Treasury yields could easily be higher. Today’s economic data and subsequent price action suggest that. Initial negative economic data was greeted by an absence of a lower yield response. Once the economic data corrected to positive, a response came forth as yields quickly moved higher. The downside for yields might just be exhausted.
Figure 1: U.S. ISM Manufacturing Index, March 2013 to Present (Corrected Final)
Figure 2: U.S. 10-Year Treasury Yield, June 2, 2014
Figure 3: U.S. 10-Year Treasury Yield, June 2013 to June 2014