Weak Manufacturing Numbers: The Latest Setback For Savers

Earlier this week, a report on U.S. manufacturing activity in May from the Institute of Supply Management (ISM) put a damper on what has lately seemed to be an increasingly upbeat economy. This setback also cast doubt on when -- or whether -- savings accounts would benefit from the recent rise in bond market interest rates.

Manufacturing slowdown

According to the ISM, overall manufacturing activity in the United States contracted during the month of May, marking the first time that has happened since November 2012.

The ISM report had three troubling aspects. First, the reference to November 2012 is ominous, since that was the middle of a quarter in which real GDP growth slumped to a barely moving 0.4 percent. Second, the Manufacturing Index reading of 49.0 for May was the lowest since June 2009, when the economy was still struggling to emerge from the Great Recession. Third, this does not appear to be a case in which an isolated signal gives a false reading. May marked the third consecutive month in which the Manufacturing Index has declined from a year-over-year perspective.

Contraction in the Manufacturing Index does not necessarily mean contraction for the economy as a whole. According to the ISM, a Manufacturing Index level of 49.0 is consistent with real GDP growth of 2.1 percent. That would not represent a return to recession, but it would represent more of the sluggish, almost sleep-walking mode the economy has been stuck in for most of the last four years.

Interest rate reaction

Throughout virtually all of May, bond yields rose in reaction to growing optimism about the economy. In part, interest rates reflect how the price of capital is affected by the strength of the economy, with greater demand leading to higher interest rates. This tends to manifest itself first in the bond market, and later in more artificially set rates, such as those for mortgages and savings accounts.

During May, yields on 10-year Treasury bonds rose by nearly half a percentage point. Mortgage rates began to rise too, though average rates on savings accounts did not. The question is, if the rise in rates was based on economic optimism, what was the reaction to the disappointing manufacturing report?

The answer is that so far, that reaction has been fairly mild. Ten-year Treasury yields dropped by just 3 basis points the day the report came out, and stabilized the next day.

For the time being then, think of the rally for interest rates as being on hold. The rise in bond yields may pause, and the eventual response of savings accounts may be delayed, until clear evidence comes along to contradict the apparent slump in manufacturing. That may happen as soon as this Friday, with the May report on employment growth. However, if that report disappoints, expect bond yields to suffer a tumble -- and take with them the hope that savings account yields will rise in the near future.