What do the latest PMI numbers reveal about the state of the economy?

On the latest edition of Market Week in Review, Consulting Director Todd LaFountaine and Chief Investment Strategist Erik Ristuben discussed flash Purchasing Managers’ Index™ (PMI) data from February, as well as the recently released minutes from the U.S. Federal Reserve (the Fed)’s January meeting and the spike in the 10-year U.S. Treasury yield.

February flash PMI data comes in strong

Flash PMI numbers for February were unveiled the week of Feb. 19 by IHS Markit, Ristuben said. As the PMI is considered an indicator of the economic health of the manufacturing sector, there was heightened interest this time around, he explained—as it marked the first release of manufacturing data since the market downturn earlier this month. “The numbers out of the U.S., Europe and Japan showed that the global economy held up well in the aftermath of market volatility,” Ristuben said. As evidence, he pointed to the flash U.S. Composite PMI™, which came in at 55.9—the highest it’s been since 2015. Both Europe and Japan also reported strong PMI numbers, Ristuben added. “Collectively, the magnitude of these readings shows that the global economy is still cranking away,” he concluded.

Market reaction to Fed meeting minutes

Shifting gears to the Fed, Ristuben noted that the central bank recently released the minutes from its January meeting—the final one with Janet Yellen at the helm. “In a nutshell, the Fed’s notes indicate an increase in expectations for economic growth,” Ristuben stated—“likely due to a combination of tax cuts and surging consumer confidence.” The central bank also pointed out that the possibility of higher inflation this year appeared more likely, he added—which, in Ristuben’s view, strengthens the case for more interest rate increases in 2018. “What’s important to note is that the Fed said all this before the surprising rise in wage growth during January—and before the stronger-than-expected Consumer Price Index (CPI) and Producer Price Index (PPI) reports,” he remarked. In other words, Ristuben said, the Fed anticipated the current increases in inflationary pressure.

How did markets react to this news? “The bond market took this as a hawkish statement,” Ristuben said—“while equities first interpreted it as more of a softer easing in monetary policy.” The stock market soon changed its mind, he added, once bond yields spiked.

What’s behind the jump in the 10-year U.S. Treasury yield?

Diving deeper into bonds, Ristuben said that as of Feb. 23, the yield on the benchmark 10-year U.S. Treasury note is hovering around 2.9%. “This marks a significant increase since early December,” he stated—“chiefly because inflationary pressures are creating the need for higher interest rates.” All that said, Ristuben and the team of Russell Investments strategists believe that the highest rates will get during this market cycle is roughly 3.0%. Why? Ristuben believes that later in the year, the bond market will begin pricing in higher recessionary risks, which will likely cause a drop in overall rates.

So, what could this mean for institutional investors? “Many have been waiting for increases in yield to improve their funded ratios—and we’re of the opinion that the bond market has given you what it’s going to give you,” he said. As for individual investors who are concerned about yields increasing dramatically, Ristuben and the team of Russell Investments strategists don’t believe this will happen. Furthermore, Ristuben said, if recessionary risks do manifest themselves soon, bonds will likely be the best thing to own—"the best diversifier against equities,” he concluded.