Recession in the Making?

Jobs market data suggests that the manufacturing slowdown is not metastasizing into full recession—for now.

After a period of being swayed back and forth by geopolitical and political news, economic data took center stage again for the markets last week.

Unfortunately, the reason the data was heard above the tumult of impeachment inquiries, Hong Kong, Brexit and the rest was that it was so dire.

Mood Darkened

The mood darkened on Tuesday, with the latest Institute for Supply Management (ISM) report on U.S. manufacturing. September’s index reading of 47.8 was down substantially on the previous month, despite economists’ forecasts for a recovery. Of the 18 industries surveyed, 15 reported contraction—the worst result in 10 years.

These numbers overshadowed Markit’s final U.S. manufacturing Purchasing Managers’ Index (PMI) for September, which came out at the same time and appeared to show consolidation in a recent gradual upturn.

The divergence may be due to the bias in the ISM survey toward larger, more globally exposed companies. The worry is that the ISM reading shows that the U.S. cannot remain immune to the global manufacturing downturn forever, and that the impact on larger companies will eventually trickle down to smaller, more domestic businesses.

Is This Time Different?

This is not the first manufacturing downturn we have seen during the current, long expansionary cycle. Manufacturing PMIs for the euro zone and the U.S. both fell into contraction between 2011 and 2013, and the U.S. index dipped below 50 again in the winter of 2015 – 16. In the end, less volatile non-manufacturing economic activity remained solid, goods inventories normalized and these proved to be mid-cycle slowdowns.

Is this time different?

Through 2011 – 13, manufacturers were hit by the euro zone crisis. Trouble for the single currency was potentially both a deep and broad threat to global business and consumer confidence, but once the European Central Bank had signaled its readiness to act decisively, the recovery was immediate and strong.

The 2015 – 16 downturn was driven by rising concerns regarding China’s growth rate and a sharp decline in oil prices. The impact was felt most acutely in China and the U.S. Once again, decisive fiscal and monetary intervention in China produced the desired policy objective, lifting growth; in the U.S., falling energy prices hit the recently booming energy sector hard, but contagion to the broader economy was limited. All of this prevented severe erosion of broader confidence.

That confidence is more fragile today.

The Conference Board’s CEO Index contracted sharply in the third quarter to its lowest level since 2009, consistent with the persistent pullback in capital spending. Not surprisingly, when we look at the global manufacturing PMI by sector, we see that capital goods have been in contraction since January.

The disruptions the global economy faces today—the trade conflict between the U.S. and China, repercussions from Brexit, the general populist turn in politics, the prospect of an angry U.S. election campaign—do not appear to have quick fixes. Monetary policy may be approaching the limits of its effectiveness. And the cycle is simply three years older.

Concerns on Hold—For Now

That is why the other closely watched data from last week were Thursday’s services industry surveys and Friday’s U.S. nonfarm payrolls print.

The resilience in services and the support that has given to employment levels, wages and consumer confidence have generally been credited with preventing the current manufacturing slowdown from metastasizing into a general recession.

The services data echoed the manufacturing surveys. Whereas the PMI came in as expected, indicating modest but stable expansion, the ISM index undershot expectations. Europe’s PMIs were also weak.

Payroll data was mixed. The headline nonfarm payrolls number was down on the previous month’s and in line with reduced expectations, as was the private payroll data that excludes temporary census workers. Average hourly earnings disappointed. But the news was not as bad as data from earlier in the week had suggested it might be, and the unemployment rate fell to an all-time low.

For now, then, concern about a full recession within the next six to 12 months can likely be kept on hold. The current malaise may yet turn out to be a third manufacturing dip within this extended economic cycle. But things still feel in-the-balance: Political tail risks are elevated, both central banks and investors will be watching data releases intently, and that remains a recipe for market volatility.