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US supply bottlenecks indicator in Fed tightening zone

Posted on Tuesday, April 20, 2010 at 03:42PM by Registered CommenterSimon Ward | CommentsPost a Comment

The recent "stealth tightening" by the Federal Reserve – removing reserves from the banking system in order to push the Fed funds rate towards the top of the 0-0.25% target band – is probably a response to stronger-than-expected economic news and associated evidence of rising capacity strains.

A measure of supply bottlenecks that has correlated with Fed policy shifts historically is the Institute for Supply Management (ISM) manufacturing "vendor deliveries index", based on the net percentage of firms reporting lengthening delivery times (a reading of 50 indicates balanced responses). This surged to 65 in March – the highest since June 2004.

The index has reached the current level on 12 prior occasions since 1950 (instances separated by less than year are counted as a single occurrence). Every case was associated with a significant rise in official interest rates – see chart. In the last cycle, the index rose above 65 in March 2004; the Fed embarked on a long series of rate hikes in June.

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