Reduction in new export orders is the most important economic phenomenon for the business cycle in recent months. It cannot be ruled out that measures to constrain international trade have had a negative effect on trade and growth. In the monthly Markit manufacturing survey, the new orders index for developed countries was at 47.4 in September. Order flows have contracted continuously since January. In these circumstances, it is not surprising that the pace of manufacturing output is also degraded in most countries. In August, it contracts in the US over a year. In emerging markets, the new orders flow index reflects a contraction at 48.7. Since the beginning of the year, the average index is at 49.7. The ISM survey export order flow index is at its lowest since the 2009 recession (the previous low point was March 2009). This reflects a particular situation that in the past has penalized the US economy. The shock is severe and international trade is no longer a source of impetus for the economic activity as in the past, but rather a constraint that permanently penalizes growth. On the graph, we observe the change of regime throughout the year 2018. Tariff measures, non-cooperative strategies and the political consequences of insufficient growth explain this change in trend. Spontaneously, we do not perceive a rapid reversal of the trend.
The other source of concern in the manufacturing sector is employment . After a strong improvement until early 2018, especially in developed countries, it is now contracting. This means that the solvent demand, which improves with the increase in employment, is deteriorating. Internal dynamics fades.
The growth of the manufacturing sector is now strongly constrained. It no longer has a strong impetus from international trade and the solvency of domestic demand is deteriorating due to the low momentum in the labor market. We can expect a negative contribution from the manufacturing sector to growth in the coming months. The only question now is whether services can compensate for this effect. Generally this is not the case. This argues for a further slowdown in activity.
The first point is the rapid slowdown in manufacturing activity in Asia. It is contracting in the 4 major countries, from China to Japan, South Korea and Taiwan. The movement is even faster for countries that are more dependent on China for product assembly. This is the case for Taiwan and Korea.
This negative shock is a consequence of Trump’s trade measures and weighs very heavily on Asia in general and China in particular. The postponement of the sanctions planned for US imports from China, which were due to take effect on 2 July, is a good thing. However, if the resumption of the Sino-American dialogue makes it possible to avoid the worst, nothing seems to be resolved on the merits and uncertainties will remain. (With regard to the Vietnam index, are you surprised by the recent interest of the American administration? Chinese activity has moved there)
Synthetic indices on economic activity and new export orders, world trade will continue to slow in the coming months as Asia has been the region most affected by the US measures.
The dynamics of the Eurozone are slowing down quickly. The advanced estimate published last week for the Euro zone has been revised downwards. In the flash estimate it still showed a contraction to 47.8 but slightly improved compared to May (47.7). The final version is 46.6. Activity is slightly worse than in May. The decline in activity is faster. In addition to the contraction in activity already observed in Germany, there are now also those in Spain and Italy. The Spanish index plunges to 47.9 and that of Italy to 48.4. The French index, although revised downwards by 52 in the estimate at 51.9, is improving compared to spring developments. Three of the four major countries in the Euro zone have rapidly contracting manufacturing activity. Will growth forecasts have to be revised downwards?
With regard to the dynamics of foreign trade, it can be seen that the profile is the same as that of synthetic indices. Germany is pulling the whole thing down and Italy and Spain are now making a significant contribution to the contraction in orders.
The German situation will continue to deteriorate. The dynamics of world trade will not reverse rapidly, further penalizing the manufacturing sector. But in addition, the slowdown in the cycle, measured here by the IFO index) will result in a slowdown in the labor market. Employment dynamics will slow down and this inflection will be all the more important as the downward nature of the cycle lengthens. As a result, domestic demand in the German economy will be weaker and could encourage the government to pursue a more flexible policy to offset the negative effects of the international environment. Let us not doubt then that all the countries in the area would benefit from it. The risk is that we really have to go into the negative part of the cycle for the Germans to react. Moreover, even if the ECB is active, as Draghi suggested last week, this will not be enough to reverse the trend.
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.