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Wall Street to Your Street


Aug 2019 Outlook: Caught Between Consumer Strength, Manufacturing Softness

The headline stories in the third quarter are focused on the continuing downgrade in growth expectations for both the domestic and global economies. While the economic growth outlook remains positive, the momentum of that growth shows meaningful signs of deterioration, particularly outside the U.S.

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Popular surveys indicate a tale of two cities. On the bright side, global consumer sectors are continuing to exhibit rather positive trends. But global manufacturing appears to be facing significant softening, particularly in the Euro area and, more specifically, in Germany, which is a leading engine of growth in that part of the world.

The Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers Index (PMI) shows a deteriorating outlook for U.S. manufacturing activity. The data is derived from monthly surveys of corporate purchasing managers gauging their outlook on future manufacturing activity. A reading of 50 or above suggests sustained growth, while a reading below 50 suggests economic contraction. As you can see in Exhibit 1, the manufacturing sector has dropped steadily to about the 50 level – which is the lowest level in several years.

Exhibit 1

The impact of trade and tariff uncertainties

We are currently in the midst of second quarter corporate earnings reports, and disappointments on the manufacturing side are consistent with the negative trends indicated in the chart.

Manufacturing CEOs are citing trade and tariff uncertainties, slowdown in capital investment, Boeing 737 MAX challenges, Brexit uncertainties, and other trade-related factors as issues in their diminished outlooks for the balance of 2019.

On the other hand, consumer consumption-related companies have been providing a more constructive outlook. This certainly would be consistent with the strong employment and low inflation reports of this year.

There are a couple of key areas that could improve the manufacturing picture. Any constructive outcome in the various tariff discussions would help remove the uncertainty currently facing business managers. Export markets are particularly important to the Euro zone, and especially to Germany. They are also significant to the U.S. manufacturing sector. An improvement in the outlook for global trade could bolster the manufacturing outlook both in the U.S. and abroad.

Continuing strength in the employment picture, which has been a driving force of the consumer and services sectors, could also aid the manufacturing sector. On the other hand, if the deterioration in the manufacturing area ultimately leads to reduced hiring plans or layoffs, that could dampen consumer demand and lead to further deterioration of the manufacturing arena.

Brexit uncertainty continues

Brexit is another factor in business and consumer uncertainty, particularly in light of the recent change in leadership in the U.K. The new prime minister in Britain is a staunch supporter of Brexit and categorically stated in his first speech that he is committed to leaving the European Union (EU) with or without a deal on the current target date of October 31.

A no-new-deal Brexit is forecast to be most disruptive to the U.K. economy. The EU continues to take a rather stern position on the terms of the U.K. withdrawal. There is not a lot of time to come up with a new deal.

Central bankers have cited many of these issues in their comments of late, suggesting that what was an optimistic economic outlook only nine months ago has changed significantly this year. Tariff disputes, Brexit, and increased uncertainty on the part of business leaders are all contributing to their most recent positions that downside risks to economic growth have increased rather meaningfully.

Validating this point of view has been the remarkable declines in bond yields over the last 12 months. Ten-year U.S. Treasury bonds have seen yields decline from over 3.0% last year to around 2.0% recently. Globally, 10-year bond yields are all at the low end of their respective ranges of the past year, with many bonds in the Euro zone still sporting negative yields.

What has become the consensus opinion among monetary policy leaders, both in the U.S. and around the globe, is that economic risks are increasing. As such, the recent hawkish or benign expectations for short-term interest rates have suddenly become much more accommodative.

Monetary policy moves

Most markets have baked in near-term reductions in short-term interest rates as “insurance” against a further loss in economic momentum. The president of the European central bank recently spoke quite liberally of expectations to see further monetary accommodation at their meeting in September.

The Federal Reserve (Fed) cut rates by 0.25% on July 31 – the first rate cut since 2008 – to a target range of 2.00% to 2.25%. This signaled a willingness by the Fed to react to the recent weakness in select economic indicators. But Fed chair, Jerome Powell, explained that the rate cut was a mid-cycle adjustment rather than part of a longer-term rate-reduction policy. Powell’s comments triggered a sudden 1.1% decline in the S&P 5001 by traders who expected the Fed to signal further rate cuts. However, while Powell didn’t suggest that there were more cuts to come, he didn’t rule them out either if the economy continued to weaken. We will stay tuned.

See July 2019 Market Recap: Fed Cuts Rates as GDP Growth Slows

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