If Goldilocks Were A Recession

Manufacturing activity expanded at the slowest pace in two years, the first of this week’s top-tier US economic data showed.

Growth concerns are rampant, and although there will still be more questions than answers by Friday afternoon, market participants should have a better sense of whether recession fears are overblown or justified.

ISM manufacturing printed 52.8 for July, the lowest since June of 2020 (figure below). However, the headline comfortably topped estimates and the production gauge registered 53.5, still solid albeit the least robust in 26 months.

Separately, the final read on S&P Global’s gauge for July was revised slightly lower from the flash reading.

New orders subindexes in both surveys are in contraction territory — 48 for ISM and 48.6 in the S&P Global report. “New orders fell at the fastest pace for over two years [but] backlogs of work continued to increase as labor and material shortages hampered efforts to process incoming new work,” the color accompanying the S&P survey said.

The ISM inventories gauge registered the highest since 1984. “There are signs of new order rates softening as panelists are increasingly concerned about excessive inventories and continuing record-high lead times,” ISM Chair Timothy Fiore remarked.

The gap between new orders and inventories is now -9.3. As the figure on the left (below) from Morgan Stanley’s Mike Wilson shows, that may not bode particularly well going forward.

I use Wilson’s visuals here to give credit where it’s due. He’s been consistent (and insistent) on this point. The figure on the right (above) gives you some context vis-à-vis US equities.

Notably, ISM prices paid plummeted to 60, the lowest since August of 2020. The MoM drop was the largest in a dozen years. Prices have “soften[ed] to acceptable levels,” Fiore said.

If you’re inclined to a constructive interpretation, I suppose you could describe this as akin to a Goldilocks report — with virtually all the risks skewed to the downside. Demand is receding, but that’s desirable at the current juncture. Price pressures are apparently moderating rapidly, although that’s likely due to falling commodity prices, which are volatile, to put it nicely. There was evidence of easing price pressures in the S&P survey as well. As long as demand doesn’t soften too much, and assuming price pressures continue to abate, the soft landing thesis lives.

However (note the emphasis), the ISM anecdotes were uniformly cautious on demand. “I believe a slowdown is coming,” one respondent said. “Growing inflation is pushing a stronger narrative around pending recession concerns,” said another. And still another: “Inflation is slowing down business.” There were also myriad references to lingering supply chain disruptions and logistical challenges, as well as pervasive staffing issues. The employment gauge remained in contraction territory, albeit just barely.

The color from Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, was the opposite of rosy. “With the exception of pandemic lockdown periods, July saw US manufacturers report the toughest business conditions since 2009,” he said Monday, adding that “a growth spurt in the spring has quickly gone into reverse, with new orders for factory goods down for a second straight month in July, leading to the first drop in production for two years and sharply reduced employment growth.” Firms cited a worsening cost of living crisis in explaining slower sales, alongside a deteriorating macro outlook.

Activity has a lot of catching down to do if consumer sentiment has anything to say about it (figure above).

I’d suggest that although inflation may have peaked, it’s not going to fall fast enough (or far enough) to offset the impact of slower growth. From my perspective, the die is cast. Headline inflation will recede in the months ahead, but it’s broadened out into enough so-called “sticky” categories that relief at the pump and in the grocery aisles will be set against an economy-wide increase in prices for pretty much everything else, while growth and employment slow.

Meanwhile, construction spending plunged 1.1% in June, separate data out Monday showed. It counted as the largest drop since early 2010. Consensus expected a 0.1% increase. That simple juxtaposition tells you everything you need to know about that print.