Factory Expansion Spurs Growth as Budget Cuts Loom

By: Alex Kowalski, Bloomberg

American factories expanded in February at the fastest pace in almost two years, spurred by a jump in orders that is helping propel an economy about to be tested by federal government cutbacks.

The Institute for Supply Management’s factory index rose to 54.2, the highest reading since June 2011, the Tempe, Arizona- based group said today. Other data showed consumer spending rose in January even as incomes plunged, and household confidence climbed last month.

Companies such as Applied Materials Inc. (AMAT) are benefiting from growing demand as businesses boost spending and economies in emerging markets pick up. Combined with a rebound in housing and sustained gains in household purchases, the factory gains will help lift growth, after the economy stagnated in the fourth quarter, even as across-the-board budget cuts set in.

“The data continue to be consistent with a moderate recovery,” said Dean Maki, chief U.S. economist in New York for Barclays Plc. “Production is picking up and that is a key reason why we think growth will be stronger in the first quarter. Underlying all this is a pretty steady pace of consumer spending. Auto sales and housing are quite solid right now. The economy can withstand some fiscal tightening without going into recession.”

Personal spending rose in January even as incomes dropped by the most in 20 years, a report from the Commerce Department showed. Household purchases, which account for about 70 percent of the economy, climbed 0.2 percent after a 0.1 percent gain the prior month. Incomes slumped 3.6 percent, sending the saving rate down to the lowest level since November 2007.

Consumer Sentiment

Thomson Reuters/University of Michigan said today its final index of consumer sentiment climbed in February to a three-month high of 77.6 from 73.8 a month earlier. The gauge was projected to match the preliminary reading of 76.3, according to the median estimate in a Bloomberg survey.

Stocks rose, reversing early losses, after the reports. The Standard & Poor’s 500 Index advanced 0.2 percent to 1,518.2 at the close in New York, after declining as much as 0.9 percent earlier.

The pickup at U.S. factories comes as the rest of world’s producers struggle to rebound. Two Chinese manufacturing indexes showed a slower-than-estimated pace of expansion in February. In the U.K., manufacturing unexpectedly shrank last month as orders plunged. Factories in the euro region contracted for a 19th straight month.

The median projection in the Bloomberg survey for the U.S. ISM manufacturing gauge was 52.5, and estimates ranged from 50.5 to 54. Readings above 50 signal expansion.

Production, Orders

The group’s measure of production increased to the highest level since April 2012, while the new orders gauge was the strongest since April 2011. The index of export demand improved to a nine-month high.

Investment in new equipment is at the root of the recent pickup in increased activity on factory floors. Orders for capital goods, excluding military gear and aircraft, have climbed 9.5 percent since October, the biggest three-month gain since 1993, according to Commerce Department figures released earlier this week.

Applied Materials, the largest producer of chipmaking equipment, forecast fiscal second-quarter sales that beat most estimates, indicating that some customers are expanding output on brisk demand for mobile devices.

“The momentum in the business is strong,” Michael Splinter, chief executive officer at the Santa Clara, California-based company, said at a conference the following day. “Our display business is starting to come back. Orders are picking up there as well.”

Auto Sales

Consumer demand for motor vehicles has bolstered business for U.S. producers as well. Cars and light trucks sold at a 15.2 million annual rate in January after 15.3 million a month earlier, according to Ward’s Automotive Group. November through January were the strongest three months of the auto industry in five years.

February sales, being reported today, show General Motors Co., Ford Motor Co. Chrysler Group LLC and Toyota Motor Corp. posted gains as low interest rates and more-available credit draws buyers to dealerships.

At the same time, the expiration of the payroll tax cut in January, coupled with climbing gasoline prices, is trimming discretionary income and may limit the gains in household purchases in the first quarter.

“It’s going to be touch and go for the consumer for the next few months,” said Ryan Sweet, a senior economist at Moody’s Analytics in West Chester, Pennsylvania, who correctly projected the 3.6 percent drop in income. “The consumer is going to be able to support the recovery, but they’re not going to be able to take it” to a higher level, he said.

Payroll Tax

Congress and President Barack Obama allowed the payroll tax to return to its 2010 level of 6.2 percent from 4.2 percent at the start of the year, which means an American who earns $50,000 is taking home about $83 less a month.

Democrats and Republicans are in a standoff over how to replace $1.2 trillion in federal budget cuts over the next nine years that begin today. Of that total, $85 billion would occur in the remaining seven months of this fiscal year.

For all the concern about the cuts, investors are signaling the economy is strong enough to weather any reductions in spending, with home sales, consumer confidence and employment all rebounding.

The S&P 500 climbed 6.3 percent this year through last week, better than the 4.1 percent gain for the MSCI All Country World Index. Treasuries were becalmed, with yields on 10-year notes ending last week at 1.96 percent, little changed over the last month. The U.S. Dollar Index, which tracks the currency against six of America’s biggest trading partners, was at a five-month high.

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