Daily commentary: On the Manufacturing PMI divergence

This week, let’s look at the global economy through a manufacturing lens. A slew of manufacturing data was released today in Asia and Europe to go along with the Manufacturing data we saw yesterday in the United States. The data show a divergence of economic fortunes that demonstrates the severity of Europe’s austerity-induced economic recession.

First, let’s look at the US data.

"The PMI registered 54.8 percent, an increase of 1.4 percentage points from March’s reading of 53.4 percent, indicating expansion in the manufacturing sector for the 33rd consecutive month. Sixteen of the 18 industries reflected overall growth in April, and the New Orders, Production and Employment Indexes all increased, indicating growth at faster rates than in March. The Prices Index for raw materials remained at 61 percent in April, the same rate as reported in March. Comments from the panel generally indicate stable to strong demand, with some concerns cited over increasing oil prices and European stability."

–April 2012 ISM Manufacturing Report on Business

Before the release of the national PMI data, many of the regional manufacturing and business activity indices showed weakness that suggested weakness for the national PMI. All of the regional indices came in below the prior month’s data and forecasts except the Richmond Fed Index.

• Dallas Fed Business Activity Index: -3.4, down from 10.8 last month.
• Kansas City Manufacturing Index: 3, down from 9 last month (7 forecast).
• Richmond Fed Index: 14, up from 7 last month (6 forecast).
• Empire State Index: 6.56, down from 20.21 last month (18.0 forecast).
• Philly Fed Survey: 8.5, down from 12.5 last month (12 forecast).
• Chicago PMI: 56.2, down from 62.2 last month (60.5 forecast).

Therefore, the strength of the US data has to be questioned given this context. We will need to see whether we have give back next month.

Nevertheless, respondents to the survey were generally upbeat based on ISM’s sampling of the commentary to its survey. Moreover, all of the important sub-indices, new orders, production, and employment are up and show expansion. Just a few days ago we showed you a chart that demonstrates this is the best manufacturing upturn in the US since the mid-1990s. So it is clear that the US manufacturing sector is doing relatively well in this recovery.

In Asia and in Europe outside the euro zone, the PMIs were also generally positive although India and China, the two markets I told you were weak, had problems.

• India: PMI up to 54.9 from 54.7 (output increases at weakest pace in 2012, new business growth accelerates, Inflationary pressures strengthen)
• China: PMI of 49.3 was higher than 49.1 flash number. It is still below 50. (Manufacturing output and new orders both fell, employment down at fastest rate in over three years, input cost inflation remains subdued)
• Russia: PMI up to 52.9 from 50.8 (increases to highest level in over a year, faster growth of new orders and output generates job creation, input price inflation remains below long-run average)
• Turkey: PMI of 52.3 (five-month high,moderate growth of output and new orders, input prices rise at quickest pace since last November)
• Taiwan: PMI of 51.2 in April, down from 54.1 in March (weakest improvement in operating conditions in current three-month sequence, Growth of both output and new orders eases, output prices fall despite solid cost inflation
• Indonesia: PMI of 50.5, down from 50.8 (Production unchanged as new order growth weakens, PMI slips to three-month low of 50.5, input price inflation reaches one-year high)
• South Korea: PMI of 51.9 (Markit: "output rose at a solid rate, largely in response to continued growth of incoming new business. This in turn contributed to another month of job creation, albeit marginal, and a solid expansion of purchasing activity.")

By contrast, the data in Europe are horrible:

• Spain: PMI at new post-2009 low of 43.5 in April from 44.5 in March including marked deterioration in operating conditions, acceleration of rate of contraction in output, substantial fall in new orders.
• Germany: PMI at 33-month low including first drop in output since December 2011, sharp fall in new work, particularly in export markets
• Italy: PMI at 43.8 including marked contraction in new orders and new export orders, and sharpest job losses in 27 months
• France: PMI down to 46.9 vs. expectations of 47.3 with new orders falling at the fastest rate in three years

You get the picture. Every one of these PMIs is below the recession demarcation line of 50 and falling. Europe is in a recession. In the euro zone, Germany is the best of the lot. While the overall German economy continues to show employment gains, it is clear domestic demand remains weak and that German growth is dependent on export demand, which is falling.

Bottom line: Europe is the weakest link in the global economy. Clearly this is due to the Europeans’ policy response to the sovereign debt crisis. As currency users without full central bank support, the euro area governments have limited fiscal space which makes austerity an inevitable policy response to rising budget deficits, irrespective of their genesis. In this crisis, the fiscal deficits in Europe are the result of increased private savings needed to reduce private debt levels. Savings levels can only be maintained by high fiscal deficits and/or improved current account. As the current account has not improved, all of the adjustment has fallen on the public sector. When the public sector retrenches in response, the result is a shortfall of aggregate demand and private sector defaults and retrenchment. Austerity will therefore always end in more private sector defaults, higher unemployment, and a potential boomerang onto asset prices This will weaken the banking sector unless policy reverses. Europe’s policy response to the sovereign debt crisis is a textbook trigger for debt deflation. I would highly advise staying clear of most European bank stocks and bonds until this phase passes.