ISM manufacturing index confirms growth slowdown

When the ISM released it’s monthly manufacturing index last month, the numbers were pretty good. The headline PMI number was lower, but still a robust 60.4. At the time, it was clear that conditions were slowing. I called a cyclical peak in early March and asked last month “Has the US manufacturing sector’s growth already started its cyclical descent?” With this month’s numbers just in, the answer is clearly yes. While the economy’s growth rate is slowing, both the economy and the manufacturing sector in the US are still expanding.

The ISM report stated:

The PMI registered 53.5 percent and indicates expansion in the manufacturing sector for the 22nd consecutive month. This month’s index, however, registered 6.9 percentage points below the April reading of 60.4 percent, and is the first reading below 60 percent for 2011, as well as the lowest PMI reported for the past 12 months. Slower growth in new orders and production are the primary contributors to this month’s lower PMI reading. Manufacturing employment continues to show good momentum for the year, as the Employment Index registered 58.2 percent, which is 4.5 percentage points lower than the 62.7 percent reported in April. Manufacturers continue to experience significant cost pressures from commodities and other inputs.

Again, the manufacturing sector is experiencing a soft patch. My focus is the nexus of a growth slowdown and less accommodative economic policy. And we are slowing.

• First quarter GDP was only 1.8% annualised.
• Housing has double dipped
• Initial jobless are back over 400,000
• The economy only added 38,000 jobs last month according to ADP

I could go on. You get the picture.

On the policy side, austerity is in. Back in late 2009, President Obama was talking about ratcheting back stimulus.

President Barack Obama plans to announce in next year’s State of the Union address that he wants to focus extensively on cutting the federal deficit in 2010 – and will downplay other new domestic spending beyond jobs programs, according to top aides involved in the planning.

The president’s plan, which the officials said was under discussion before this month’s Democratic election setbacks, represents both a practical and a political calculation by this White House.

–After spending binge, White House says it will focus on deficits – Politico

My response was to say that I am now moving from multi-year recovery to a double dip baseline.

The only way to both add stimulus and reduce the deficit is to increase taxes – on whom is the only question. Obviously, adding stimulus while increasing taxes sounds a lot like ‘tax and spend’ and opens the door to all manner of attacks from the right. This is a huge tactical error that will be both politically damaging and unlikely to actually stimulate the economy. I see this as a potentially catastrophic outcome for Democrats.

Here’s the thing, though. While the President was talking about deficits, he never did cut the deficit. Nor did he increase taxes. So the double dip never happened. I suspect the President’s about face was due to the lack of job growth. He realised at some point that cutting spending or increasing taxes in a weak economy meant a double dip.

Nevertheless, the real economy was just weak enough that the political savaging for Democrats I envisioned for 2010 occurred nonetheless. So here we are with the political realities being the same. Deficit spending on today’s scale is politically unacceptable and will come to an end via spending cuts or tax increases. Because the Republicans control the House of Representatives, it is going to be spending cuts rather than tax increases.

Moreover, the Fed cannot help here since interest rates are already zero percent. It has tried quantitative easing as a policy tool but Ben Bernanke has said he expects fiscal policy to do the heavy lifting.

The bottom line for me is that the soft patch in and of itself is not a problem. There is always some sort of mid-cycle slowdown. The real problem for economic growth bulls (and risk assets) is that this particular soft patch is increasingly likely to be met with austerity and contractionary fiscal policy.

Source: May 2011 Manufacturing ISM Report On Business® – ISM