Oct. 2 (Bloomberg) -- Listening to factory purchasing managers and homebuilders, it’s easy to see why Vincent Reinhart believes the U.S. economy is on the verge of taking off even as the federal government shuts down.
A pickup among leading indicators such as the Institute for Supply Management’s factory index and homebuilder confidence is evidence that the expansion will accelerate, according to Reinhart, the New York-based chief U.S. economist at Morgan Stanley. The manufacturing gauge climbed last month to its highest level in more than two years, while builder sentiment held at an almost eight-year high.
The economy’s resiliency in the face of broad federal spending cuts and flagging global markets is proof of its underlying strength, says Reinhart. As those headwinds and the lingering effects of the recession, including tight credit and consumer deleveraging, begin to fade, companies and households will boost spending, leading to a 2.75 percent average growth rate through 2015, he says.
“The data that have come in of a forward-looking nature, importantly including purchasing managers, do suggest that the economy is picking up,” Reinhart said in an interview today. “The key mechanism that gets us that inflection point is capital spending. Firms begin to feel more confident.”
The projection, which he first issued in March, marked a change in the outlook for Reinhart. He and his wife, Harvard economist Carmen Reinhart, laid out a case for slow recoveries from deep recessions in a 2010 paper at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming.
The rebound in factory and homebuilder confidence is coming right on cue in support of a brighter outlook. Manufacturing sentiment has been stronger than economists projected every month since July, when the ISM index jumped to 55.4 from 50.9 the prior month, its biggest gain since 1996. A report yesterday showed the measure rose to 56.2 in September, beating the median estimate of economists surveyed by Bloomberg. Fifty is the dividing line between growth and contraction.
An increase as large as the 7.2 points gained since reaching a four-year low of 49 in May was last seen when the economy was emerging from the recession in mid-2009. Such advances are historically associated with economic turning points, Morgan Stanley research shows.
“Three months in a row here with very solid numbers suggests that manufacturing in the U.S. is very strong and well positioned for continuing strength,” Bradley Holcomb, ISM’s factory survey chairman, said in a press conference yesterday. “It certainly is a good sign for the economy.”
ISM readings as high as last month’s typically coincide over time with an economy growing at a 4.4 percent pace, according to the Tempe, Arizona-based group’s research. The nation’s gross domestic product expanded 1.6 percent in the year ended June, according to Commerce Department data.
“You really have to rework your thinking about what’s going on out there,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “The resurgence in manufacturing is a good factor for the economy right now. World growth is coming back online faster than people think.”
The growth in manufacturing combined with gains in employment and an improving housing market means economic growth is more likely to catch up with the forward-looking measures such as ISM, rather than the other way around, according to Carl Riccadonna, senior U.S. economist at Deutsche Bank Securities. Over the past decade, the factory gauge has had a 67 percent correlation with GDP, he said.
“We’ve had a very sluggish economic recovery, so if the recovery is plodding along, those lagging indicators are going to plod along in due course as well,” said Riccadonna. “We are heading in the right direction here because the leading indicators are improving.”
The National Association of Home Builders/Wells Fargo confidence index registered 58 last month, matching August’s reading as the strongest since November 2005. Figures greater than 50 mean more builders view conditions as good than poor.
“Households are more willing to take on debt, there are stronger income prospects, housing is accelerating from record-low levels, all of this contributes to economic activity,” Riccadonna said. “It’s really a domestic story.”
That momentum could be slowed by infighting in Washington, after discord over President Barack Obama’s Affordable Care Act plunged the federal government into its first partial shutdown in 17 years. The standoff comes just as the Treasury starts using final extraordinary measures to avoid breaching the nation’s $16.7 trillion debt ceiling. The administration says the limit will be reached by Oct. 17.
“Politicians may very well be putting at risk the pickup in growth,” said Reinhart. “Confidence is something that can be derailed by Washington, D.C. Uncertainty poses a cloud that can impair capital spending.”
Stocks fell today as the government shut down for a second day. The Standard & Poor’s 500 Index declined 0.1 percent to 1,693.87 at the close in New York.
“What’s going to drive the politicians back to the negotiating table is constituent pressure, but the main source of that constituent pressure would be wealth losses,” including a selloff in stocks, said Reinhart. “If the shutdown goes into next week, then people will begin to increasingly worry.”
Uncertainty in the near-term could set back gains made in the labor market, where a drop in jobless claims, another leading indicator, points to a strengthening. The number of people filing applications for unemployment benefits averaged 308,000 in the four weeks ended Sept. 21, the least since June 2007, before the recession began.
A decrease in dismissals is usually a harbinger of a boost in employment. With companies already running lean after the recession, even the slightest pickup in demand will require more hiring and greater capital investment, said Deutsche Bank Securities’ Riccadonna.
Companies added fewer workers than projected in September, indicating the job market is struggling to gain momentum, a private report based on payrolls showed today. The 166,000 increase in employment followed a 159,000 rise in August, according to the ADP Research Institute in Roseland, New Jersey. The Labor Department’s figures, due in two days, will be delayed if government offices remain closed.
Nonetheless, the recent data indicate the economy is now better positioned to overcome any hurdles, said Bank of Tokyo-Mitsubishi UFJ’s Rupkey.
“This looks a little more lasting,” Rupkey said. “Each new year past the recession, the economy should be building momentum which is sustainable,” he said. “We’re in the fifth year here, and we’re seeing it.”
To contact the reporter on this story: Victoria Stilwell in Washington at email@example.com
To contact the editor responsible for this story: Chris Wellisz at firstname.lastname@example.org