Manufacturing, the Job Market, and Recession

The ISM Manufacturing Index surprised to the downside, falling further into contraction in September and renewing recession fears. The Non-Manufacturing Index also came in lower than anticipated, but remained consistent with an expansion in the overall economy (but at a slower pace). The Employment Report was mixed, but helped to offset concerns that we have entered a downturn. Yet, that was never much in doubt. The worry is that the economy may slip into a recession in 2020. The 2020 outlook revolves around trade policy, changing demographics, and the Fed. We’ll hear from Chair Powell this week.

We’ve often experienced contractions in manufacturing with a downturn in the overall economy. That was the case in 2015-2016, when a correction in energy exploration contributed to declines in industrial production and business fixed investment. Unlike that slowdown, the current weakness is largely self-inflicted. U.S. manufacturers use parts and supplies from around the world. Tariffs, particularly the May 10 escalation, raise costs, invite retaliation, and disrupt supply chains. Firms report a lack of visibility on prices for inputs from abroad. Many don’t know if they will be able to get supplies next year. The uncertainty undermines business fixed investment. While a completed trade deal with China appears unlikely, a truce in trade tensions ought to be viewed favorably. This could include a postponement of the final round of tariffs on Chinese goods, or the rollback of some of the existing tariffs. However, following last week’s WTO ruling, tariffs are set to rise on goods from Europe (again, it is U.S. consumers and businesses that pay the price).

The ISM survey results are diffusion indices and do not measure actual activity. They are more like a sentiment gauge. Small moves in the headline figures are essentially irrelevant. The numbers often bounce around from month to month. However, a trend higher or lower is significant – and the decline in the manufacturing gauge in August and September coincides with other indicators of factory sector weakness.

Scott Brown
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The ISM Non-Manufacturing Index is more indicative of overall economic growth. The survey results were unexpectedly strong in August, but surprisingly soft in September. Don’t read too much into that. A further decline in October would be unsettling, but we won’t know until we get that report.

Manufacturing and business fixed investment are in a slow patch, to be sure, but consumer spending accounts for 68% of Gross Domestic Product. Strong household fundamentals are expected to support spending growth well into 2020. However, if the economy were to enter a recession, we are most likely to see it in the job market. The unemployment rate is a lagging indicator. Nonfarm payrolls are a coincident indicator, and jobless claims are a leading indicator. Nonfarm payrolls are still growing, indicating that we are not in a recession now, and claims are still trending at a low level, suggesting that we’re not likely to be in a recession anytime soon.