Thursday, August 19, 2010

Looking Under the Hood of the Philly Fed Index Report

After mentioning the positive surprise in the July industrial production and July capacity utilization numbers in yesterday’s Industrial Production and Capacity Utilization Since 1988, it is only fair to note that today’s Philly Fed index painted a much uglier picture of the manufacturing landscape.

Officially known as the Philadelphia Fed’s Business Outlook Survey, the Philly Fed index is derived from a monthly survey of manufacturers in the Third Federal Reserve District, which is comprised of Delaware, the southern half of New Jersey and all of Pennsylvania except for about the westernmost quarter of the state. Manufacturers are asked to indicate the direction of change in overall business activity and in the various measures of activity at their plants: employment; working hours; new and unfilled orders; shipments; inventories; delivery times; prices paid; and prices received.

The results of these surveys are used to create a regional ‘diffusion index,’ which is essentially the percentage of respondents who see an increase in activity minus the percentage of respondents who see a decrease. Respondents are asked to evaluate both current activity (current month versus last month) and their expectations for future activity (six months from now versus current month.)

The number that hits the headlines is a composite ‘general activity’ index covering all aspects of current activity. Today that number was -7.7, down from +5.1 in July. The number that rarely is reported is the future ‘general activity’ index, which fell from +25.0 to +19.6. (see press release and summary of returns table for additional details)

The chart below captures 15 years of both the current and future general activity data, with recessionary periods shaded in gray.

I also like to look at some of the component data. Three of my favorites are new orders for a glimpse into the future, shipments for a sense of the current level of economic activity and employment, particularly given the heightened sensitivity to this issue and the need for wages to help repair the consumer balance sheet. The chart below captures all three of these components of the general activity index in the same format (percentage of respondents reporting an increase in activity minus those reporting a decrease.)

The chart shows that while new orders have slipped from July to August, manufacturers in the Philadelphia area are still optimistic about an increase in orders six months from now and are even more optimistic this month than last month, reversing a declining trend. Shipments have also showed a decline from July to August, but again, respondents are optimistic about the situation six months from now.

What really got my attention was the employment diffusion index, which shows relatively flat current employment from May to the present, but fairly significant declining expectations about employment six months from now. In fact, expectations are now for a slight decline in employment six months from now – the first time that manufacturers have been expecting a net decline in employment in over a year.

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[source: Federal Reserve Bank of Philadelphia]

Disclosure(s): none

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