Manufacturing solid, economy improving

INDICATOR: June Supply Managers' Manufacturing Index and May Construction

KEY DATA: ISM (Manufacturing): down 0.1 point; Orders: up 2 points: Employment: flat/ Construction: up 0.1%

IN A NUTSHELL: "Manufacturing activity remains solid and the sharp rise in demand points to improvement going forward."

WHAT IT MEANS: We know the economy went backwards sharply during the winter, but where are we now and where are we going? It looks like the economy is accelerating, but maybe not as rapidly as most of us had hoped. The Institute for Supply Management's June measure of activity eased a touch but the May level was the highest in five months. In other words, the winter wipeout has been wiped out. On the positive side, new orders surged and that is good news for future production, which moderated. However, the level of the production index remained quite high, so we are not talking about any major retrenchment. Export demand continued to grow, but less robustly while imports accelerated. Despite the new orders growth, backlogs fell and that may be the reason that hiring didn't pick up. We get the employment report on Thursday and it should be really good, but manufacturing may not be the prime driver of the gains.

In a separate report, construction activity increased less than expected in May as residential activity declined. The good news is that the government is back building infrastructure again as spending on roads, water and sewer projects, power and transportation needs were all up solidly.

MARKETS AND FED POLICY IMPLICATIONS: Last week we saw that consumer spending was nothing special in May and that has raised some questions about how strong growth was in the just completed second quarter. We know that households bought lots of motor vehicles. Indeed, it looks like the June numbers will be even better than projected. But spending on most other goods was moderate, at best. Disturbingly, demand for services, the largest component of demand, was up minimally. Maybe the warm June caused utility demand to jump, but right now, it is hard to see growth above the four percent growth pace I have been forecasting. But that doesn't mean the economy is weak or soft or not accelerating. The manufacturing sector is not doing well because the rest of the world is growing rapidly. It is doing well because domestic demand is on the rise. So I still think it is possible that the second half of the year will see strong to robust growth, but until that happens, it will remain a hope. And the Fed is not operating on hopes and prayers. Chair Yellen may not be from Missouri but she seems to believe in the state's nickname of "Show Me". Until growth really does hit its stride, the Fed will be keeping rates low. As for investors, it's the first day of the new quarter and they also seem to be willing to believe that rates will remain low and the markets can rise until they are shown that is not the case.