Are We Headed For a Double Dip Recession? Part 2: The Producer Side

(Continued from Part One.)

Companies, meanwhile, are doing well. They are generally sitting on cash reserves, funds are relatively easy to borrow and rates are low, but firms are becoming cautious of future demand. PMI indexes in the US, Europe and Asia are all down. Euro zone PMI hit a seven-month low in May, and the US Institute for Supply Management’s index of manufacturing activity dipped well below forecasts.

Even China’s PMI has dropped further, back to the mid-2010 level when Chinese PMI last eased back. How much further it has to go remains a big question, but our reading is China will maintain at least 7-8 percent growth this year and is largely engineering a soft landing for the economy. In addition, China’s absence from the commodities markets, at least for the base metals, has been a contributing factor in weakness of metals prices over the last month or so.

In the context of the global economy, slower (if still positive) growth in China is not going to help Western exporters looking to rely on manufacturing companies to pull them out of recession. Manufacturers exporting from the US and Europe have been part of the success story in a rebound in manufacturing activity during 2010 and early 2011, but slowing growth in Asia, led by China, and in Western markets is adding to a general malaise in this sector with little sign of a pickup this year.

Other data points are supporting the picture of slowing demand. In a recent note to investors, Standard Bank advised, “US durable goods data showed inventory levels of manufactured durables and transportation equipment continue to rise. In fact, US inventory levels increased for the sixteenth consecutive month in April. We view the build-up in inventories as a signal that producers aren’t able to push inventory towards consumers because of weak final demand.”

This supports most commentators’ view that domestic consumption is unlikely to come to the rescue. Much depends on confidence and the latest employment figures are not providing much of that. ADP Employer Services reported that US private sector payrolls had increased by just 38,000 last month, far fewer than expected. Friday’s official employment report showed the jobless rate climbing to 9.1 percent, and only 54,000 added payrolls. (Citi and Goldman Sachs estimated an increase in total payrolls in May of only 100,000 versus a consensus call at the start of the week that was just shy of 200,000.)

We expected employment edging higher. Employment worries, continually falling house prices and rising gas prices have all hit consumer confidence just as Euro debt worries, the supply chain effects of the Japanese earthquake and slowing growth estimates for Asia are weighing on market sentiment. Will it turn around or are we in for a double dip?

While PMI and other indices are moving downwards, they are still in positive territory, but clearly US and European administrations are worried. There is not much Europe can do with different economies moving in almost opposite directions, but in the US there has been talk of a ËœQE3.’ It probably won’t happen, but underlines the fear that only drastic action will stimulate a return to the progressive improvement of the last 18 months.

With an election around the corner and a massive budget deficit, neither party is going to support action that would cause a change in the status quo for fear of upsetting one section of voters or the other. We are therefore probably in for a stagnant growth period until house prices finally bottom and some semblance of confidence slowly returns. Meanwhile it’s hard to see where the impetus for strong rises in commodity prices is going to come from, unless China in particular and Asia in general surprises on the upside.

The Chinese authorities appear comfortable with their war on inflation and single-digit growth rates. If inflation does start falling for consecutive months, they may loosen controls towards the end of the year that would see a pick up in 2012. For now, we could be back to “tighten your belts time, at least for 2011.

–Stuart Burns

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