The publication March’s Markit indices confirms the downward pressure on activity in the manufacturing sector. The leading indices published for the Euro zone, Germany and France, on March 22, have been revised downward. This is never a very good signal as to the strength of the activity. This revision was marginal in the Euro zone (from 47.6 to 47.5) and in France (49.8 to 49.7) but more marked in Germany from 44.7 to 44.1. This latter has not been so low since July 2012. For the Euro zone, the index has not been as low since June 2013 but at the time the movement was bullish while here it reflects a deterioration of the activity. For the other two major countries, Spain and Italy, there is a slight rebound in Spain from 49.9 in February to 50.9 in March, but the Italian situation continues to deteriorate, from 47.7 to 47.4.
A good explanation is the pace of international trade. Germany is frankly penalized by the contraction of trade due to an openness rate higher than 44% of GDP. Any shock on world trade has an immediate impact on it. More generally, because of the intensive trade between countries of the zone, any external shock is amplified by a contagion effect and penalizes the activity of all. This had been a very positive uptrend in 2017 but is declining today. Germany saw its export orders revised downwards compared to the March estimate (38.9 vs. 39.5 initially). For France, the figure is unchanged.
The proactive economic policy of the Eurozone can only be seen on monetary side with a very accommodative policy but it cannot go further in that direction to limit the impact and the spillover effect of the shock. Except for a sudden and unexpected reversal of world trade, the trend in the Euro zone is here to stay. It should be possible to support domestic demand for this through budgetary means. This is not the current mood at the European level even if France plays constrained by the social unrest
The modest rebound in the IFO index in March is sometimes interpreted as the counterpoint to the drop of the Markit index released last Friday. There is indeed an opposition in March between the pace of the two indicators. One goes up again while the other is down.
However, what shocked in the Markit survey is the sharp downturn in the manufacturing sector, while the services sector was doing quite well. The manufacturing index was 44.7 against 47.6 in February. It contracts for the third month in a row. In contrast, the composite services indicator (calculated as the non-manufacturing ISM) is stable in March at 53.7 as in February. The culprit is the manufacturing index. Yet when comparing the manufacturing index of Markit and that of the IFO we have exactly the same profile.
The peak of the two indices is almost the same and the break observed since the beginning of 2018 is similar. The shock on the German economy reflects the rapid slowdown in the world trade momentum. The impact on the German economy is through the manufacturing sector whether measured by IFO or Markit. The pace of service between the two measures is not the same and this is what differentiates synthetic indicators from the two surveys. But services are more reflective of the domestic market than the sensitivity of the German economy to world trade via the manufacturing sector. The external shock is strong and brutal in Germany and it has first to be stabilized before the beginning of a recovery. It will take time and this justifies the pessimistic forecasts for Germany.
ISM index dropped: a healthy adjustment. In the USA, the fall of the ISM may reflect a return to a more normal situation? For many months, this indicator for the manufacturing sector was well above the CFNAI index which is a measure of 85 indicators of the economic activity (prepared by the Chicago Fed). This situation, which has been a regular occurrence since 2004, always ends with a sharp and brutal adjustment of the ISM to the CFNAI. The adjustment always takes place in this direction. Finally, the overly optimistic expectations contained in the ISM index adjust to the “real economy” which does not present excessive optimism. This adjustment is rather healthy.
The French government is still expecting a robust recovery for the last three months of 2018 and for 2019. Companies’ surveys for October do not allow such optimism. The main point is the rapid slowdown in the manufacturing sector. It was the leading sector in 2017 and its dynamics was an important contributor to the strong expansion seen this year. It was a source of impetus for the rest of the economy. Its current lower momentum is a source of concern. The retail sales sector is weak reflecting question on purchasing power for every French consumer. My expectations is that the French economy is back to the trend seen before 2017. It means that the forecast for GDP growth is close to 1.4%. This is consistent with what these surveys say. No strong recovery is expected and the French economy will converge to its potential growth which is lower than 1.5%.
The following graph shows the transitory recovery of 2017.
The economic environment is changing. The world Markit index level in the manufacturing sector is still showing growth (index at 53 above the threshold of 50) but it is trending downward since the peak of December 2017.
This new pace can be seen on the graph below where the world index, with a 3-month lead, is compared to the world trade yearly change. The consistency seen between the 2 suggests that world trade will falter in coming months.
I have added the new export index on the graph. It shows a rapid decline in May and June, probably a consequence of the uncertainty on world trade after the White House decisions on tariffs. The short term dynamics on the economic activity may be lower than expected.
The world trade rebound will continue in the forthcoming months. That’s what the graph between world trade growth and the Markit index suggests. The robust level of the manufacturing index is consistent with a stronger momentum on world trade.
Every region of the world shows an improvement in the manufacturing activity according to Markit. This will support a balanced growth scheme at the world level.A higher Markit index will boost trade and therefore world growth.
The momentum at the world level is strong and robust. The Euro Area is in a catchup period with a high momentum on new orders and on employment. The business cycle is virtuous. There are reasons to be optimistic on the Eurozone environment.
The situation is more specific in the US after hurricanes. The most important contributor to the ISM increase is the item on delivery. There were strong needs and it was difficult to deliver due to disruption and delays.
The situation is robust in Japan and the Brits are still optimistic on their activity.
Indices for emerging countries are robust. The situation is good for emerging countries: growth in developed countries + higher commodity prices + growth in China is steady + good financial conditions (the impact of Fed’s hikes on interest rates have been very limited)
The marginal slowdown is associated with a marginally lower index in China.