Manufacturing Contracts-New Orders Down-Economists Worried: RECESSION Coming?

June was not a good Month for the economy.  According to the Institute for Supply Management, manufacturing numbers dropped for the first time in almost three years (since July 2009). The purchasing managers' index dropped from 53.5 in may to 49.7 in June (a consensus of economists had expected it to drop but only to 52), signalling a slow down in the economy.

The two big reasons for the decline were new orders and production. The new-orders index plunged to 47.8 in June from 60.1 in May, while the production index slowed to 51.0 from 55.6. The employment index was little changed, slipping to 56.6 from 56.9.  The inventory index fell to 44.0 from 46.0. The exports index dropped to 47.5 in June from 53.5 in May.  U.S. manufacturers saw price pressures continue to ease last month. The prices index dropped to 37.0 from 47.5 in May and 61.0 in April. May's level was the first reading below 50 since December 2011.

Many economists and others involved in manufacturing weighed in and most of them are concerned that the results may indicate further slowdown:

• If you haven’t heard the news: stay on vacation, no reason to hurry back. This economy is going nowhere according to the purchasing managers at manufacturing firms. The latest reading from the Institute of Supply Management is saying the economy’s engines have gone into reverse at the start of the summer. –Christopher Rupkey, Bank of Tokyo-Mitsubishi

• The fall in June’s ISM manufacturing index to below 50 for the first time since the last recession is the surest sign yet that the US is catching the slowdown already underway in Europe and China. But the index does not suggest that another recession is looming. –Paul Dales, Capital Economics

• We never expected anything like the magnitude of the decline in the new orders index in June. The drop of 12.3 points in the orders index is the largest since October 2001 (when, in the wake of 9/11, the index dropped 12.4 points) and the second largest decline since December 1980. Thus we are dealing with an event that occurs in roughly one in 100 reports. The question, which we cannot answer at this point, is does this represent volatility reflecting fears over Europe (the export order index fell six points) and will orders bounce back (as the orders index did in November 2001) or is it a slide into something more worrying? –RDQ Economics

• The chairman of the Survey Committee struck a cautious tone. He said that we need more data and that it is too early to be concerned. However, he also noted that manufacturers have “tapped on the brakes” and are not sure what lies ahead. This is exactly my interpretation of events. While I would concede that there are legitimate reasons to be concerned about the global economy, especially for manufacturers (note that the ISM exports measure fell below 50 for the first time since, you guessed it, 2009), I think the U.S. economy faces a bigger, home-grown problem. Firms are indeed tapping the brakes because they have decided to sit on their hands in the face of unprecedented uncertainty around the policy backdrop. I cannot imagine a significant acceleration in activity before November 6. Having said that, the abruptness of the deterioration signaled by these data strikes me as a bit exaggerated, a notion that would certainly be supported by the Markit PMI released earlier this morning. I would agree with the ISM spokesman that we need more data before we get too panicked. –Stephen Stanley, Pierpoint Securities

• Customers’ Inventories rose to a seven-month high, but since it’s still below 50, it’s not flashing an oversupply condition. Customers’ Inventories is an inverse indicator of New Orders – the lower, the better – and suggests continued gains in New Orders. Readings above 50 are reserved for recessions. But there might be for labor: The negative New Orders-Employment spread (-8.8 points) was the biggest since 1980! Future demand contracting versus growing labor costs suggests balance sheet adjustments in the form of labor cost cuts in the manufacturing sector–Jonathan Basile, Credit Suisse

• The share of businesses reporting more orders still outnumbered those with weaker orders (although by a slim 1 percentage point margin. However, the net margin of rising/falling demand for exports fell to -5, the weakest since April 2009.) These patterns suggest businesses have become a bit more cautious about their second half of 2012 plans and may be deferring major decisions until the dust from the eurozone financial crisis and the fiscal cliff in the US clears a bit. Consistent with that interpretation, the employment index fell only slightly (to 56.6 from 56.9) with the proportion of firms increasing payrolls outnumbering the portion with slimmer headcount by a still robust 15 percentage points. Overall, we see this report as confirming suspicions that the deepening slump in Europe and the slowing Asian economies are fostering greater caution in the US but, for now at least, no wholesale cuts in activity. –David Resler, Nomura Global Economics

• Assuming the pace of decelerating activity continues, and we make that assumption, it is only a matter of time before the service sector mirrors the real goods slowdown and overall employment gains moves from sluggish to worse. The markets can continue cheering each new policy initiative adding liquidity to the capital markets, especially in Europe, but today’s ISM data proves out the bigger issue — insufficient demand for credit rather than an insufficient supply. –Steven Blitz, ITG Investment Research

• We believe the weakness in Europe is weighing on the manufacturing sector, but that increasing domestic demand is likely to keep the overall economy growing. This idea was reinforced by the employment index, which declined only slightly to 56.6 in June from 56.9 in May; this suggests that manufacturers do not see the weakness in foreign orders as causing a deep enough slowdown to merit cutting employees. –Cooper Howes, Barclays Capital

Clusterstock puts these numbers into perspective. This chart shows the change in the New Orders Index compared to the previous months. The last time there was a worse decline, it was right after 9-11 and the time before that it was in the early 80s.

As it is the first week of the month, the Friday the new unemployment figures come out.  Unemployment in the US rose to 8.2% in May so all eyes will be looking at the June numbers as an indication of whether Obamanomics has any hope of improving our economy.