Wednesday, October 1, 2014

Manufacturing still looks strong

Against a backdrop of renewed doubt and uncertainty (Eurozone deflation? Russian aggression? China slowdown? Asset market bubbles ready to pop?), it is reassuring that news released today from the Institute for Supply Management shows the U.S. manufacturing sector remains quite healthy. 

The ISM manufacturing index slipped at little in September, but is still consistent with fairly robust conditions. As the chart above suggests, real GDP in the third quarter is likely to be in the range of at least 3%, which would actually represent an improvement from the average growth rate of 2.2% over the past five years..

The export orders index also slipped a bit, but it is running about average for the current expansion. At the very least there is no sign here of any significant deterioration in overseas demand for U.S. goods, and that implies that the rest of the world is at least not on the verge of another recession.

The prices paid index suggests some moderate inflation pressures, but nothing out of the ordinary.

The employment index slipped a bit, but remains relatively strong. This suggests that in general, businesses remain optimistic enough about the future to expand their hiring.

This chart paints a very clear picture of this year's divergence between the U.S. and Eurozone economies. It's quite unusual, which is why the market is worried.

The good news from the Eurozone is that swap spreads are relatively low, which in turn suggests that systemic risks are low and the economic and financial fundamentals in Europe remain positive. The Eurozone economy is suffering from external shocks (e.g., Russia, Ukraine) and policy missteps (e.g., fiscal austerity via higher taxes), but not from overly restrictive monetary policy. Manufacturing conditions have deteriorated this year, but that's not necessarily going to lead to a big recession. If anything, the relatively low level of Eurozone swap spreads is encouraging. It's much easier for economies to recover from problems when financial markets are liquid and healthy. If swap spreads were a lot higher, that would be a different story.


Benjamin Cole said...

The ECB has a monetary noose around the neck of the European economy. Egads. They tried that in Japan for 20 years---and they still say Japan needs structural reforms. In other words, tight money does need bring about structural reforms, only stagdeflation.
Think about it: would tight money fix the USA's demented pinko ethanol program?
Tight money does not work. See Europe. See Japan. See the USA 2008.

Anonymous said...

I don't think swap spreads, loose money, or what ever will help Europe. They need to get back to nation states with national currencies and form some sort of free trade zone among themselves.

How refreshing it would be for them to stop blaming Germany for all their problems.

Vespasianus said...

There's a tendency in Europe to believe that monetary policy will solve all the problems, even the non-monetary ones.

Despite the lack of a formal QE program, monetary stance is very accommodative, and the ECB keeps ultra-low rates.

The problem lies in bad policies (anti-business, anti-growth, suffocating taxation) in many core European countries.

No central bank in the world can change or balance that issue.