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Will a manufacturing recession end the recovery?

John Redwood, Charles Stanley's Chief Global Economist, looks at some recent disappointing data and looks to central banks for action.

Will a manufacturing recession end the recovery?

John Redwood


The share markets were spooked by two main developments at the end of last week. The German PMI for manufacturing fell to 44.7 implying a downturn in output. This indicator assesses orders, work in progress, production, supplier deliveries and employment. It acts as a harbinger of growth or decline, with a number over 50 pointing to expansion. The interest rate on a ten-year bond in the US fell below short rates, which is often seen as a forecast of an overall recession. When short rates are higher it means the market expects the central bank to have to cut them in due course, which would imply weak activity and no inflation threat. What should we make of these news items?

The German manufacturing figure confirmed a trend of declining orders and sales that has been going on for many months. In the all-important car industry German exports have been hit by the fall in sales in China, Germany’s largest market, and by reductions elsewhere, including the US and the UK. The German manufacturing PMI has been falling for many months following the high of 63.3 which it hit at the end of 2017. Chinese car sales have been affected by the imposition of a 10% purchase tax on new vehicles, and by the trade war. Some of the German car manufacturers supply some of their vehicles to China from their US plants, and now face a 40% tariff on US cars into China as part of the Chinese response to Mr Trump’s tariffs. There have also been some negative sentiments in China about certain types of conspicuous consumption, which includes luxury foreign vehicles.

The service sector in Germany is still in good health, offering considerable support for total activity at a time of manufacturing weakness. The latest IFO survey of business conditions showed a small gain in March implying the economy might avoid an overall recession. The manufacturing part of the IFO survey however continued downwards to just 6.6 from 15 at the end of last year. There will be some unhelpful effects from weaker car demand in the car-making areas, as it will start to have an impact on employment and earnings as the factories slow their production and reduce their shifts. The car market has been disrupted by the introduction of the new emissions standards in September 2018 and by the growing consumer worries about the future tax and regulations affecting diesel cars in particular. The German and European industry had geared up to produce and sell many more diesels this decade in response to the wish to cut carbon dioxide emissions through the greater fuel efficiency of the diesel engine, in time for governments to move on and want electric cars to replace diesels.

In the USA car sales have also fallen a bit. This resulted in part from the higher interest rates set by the Federal Reserve and the knock-on effects to car loans. More recently the Fed has announced it does not plan any further immediate rate rises, and is trying to reassure markets that advancing sensible levels of credit for new homes and new cars is fine.

The collapse of longer-term interest rates in European and Japanese bond markets as well as in the US in the last couple of weeks reflects a general view that central banks have to abandon last year’s plans to get closer to an old “normal” by tightening credit and putting rates up. The world economy needs more monetary stimulus, not less. Inflation is not a major threat in the advanced economies, whilst slower growth is an unacceptable danger. Markets are trying to push the Fed and the European Central Bank into a looser policy given their fears about output. So far, the Fed has responded by announcing an end to reducing its bond portfolio and stating it will be patient about any more rate rises. The ECB has proposed more support for the commercial banking sector come the autumn. Maybe it will take accelerated action by the ECB to stimulate more lending in the Euro area, and maybe markets would like the Fed to go even further in reassuring no rate rises with the possibility of a rate fall in due course.

These figures do not change our view of where we are. We do not think this is the end of the cycle, and think action taken so far will just be enough to avoid recession in the US and even in the Euro-area as a whole. There is already a recession in Italy, and an industrial recession in Germany, with Chinese manufacturing for export also weak. The growth of services and technology provides a strong offset which should be sufficient to avoid a general world downturn.

What will it take to get manufacturing advancing again? A trade deal between China and the US with a visible path to lower tariffs would help. Some tax cuts for the sale of more cars, with less uncertainty around future taxes and regulations hitting traditional diesel and petrol cars would help. Ensuring a sufficient supply of credit for car loans is also critical in an industry that relies heavily on sales paid for by loans or leases. The general move to looser money, lower interest rates and a bit more credit should be enough to turn things round later this year. Germany will continue to flirt with recession all the time the world car market remains weak thanks to taxes and regulations that put people off buying traditional cars.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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