KEY DATA: ISM (Manufacturing): -2.1 points; Orders: -3.6 points; Jobs: -4.3 points/ Construction: +0.1%; Private: -0.1%

IN A NUTSHELL:  “With manufacturing now starting to contract, it is even more critical that the consumer keeps spending.”

WHAT IT MEANS:  The canary in the mine may be falling off its perch.  For the first time since August 2016, the Institute for Supply Management’s (ISM) manufacturing index dropped into negative territory.  And the details were even more distressing.  Only one of the major sub-indices, supplier deliveries, was positive and it isn’t even clear that the slowing of deliveries occurred for good reasons.  One respondent noted that: “Tariffs continue to be a strain on the supply chain and the economy overall.”  That is, it may, at least in part, be getting harder to get inputs because of the trade war rather than because of excess demand.  Thus, I am not so sure we should put that index into the positive camp.  On the other hand, orders were weak as the index went negative for the first time since December 2015.  Export demand is disappearing.  As a consequence, production is declining, hiring is faltering and order books are thinning.  In other words, this was an ugly report.

The construction sector is not doing much better than manufacturing.  While building activity was up a touch in July, it was the government that was leading the way.  In the private sector, a pick up in residential building was more than offset by weakness in nonresidential construction.  Eight of the eleven components were down, including that the weakness is broad based.  MARKETS AND FED POLICY IMPLICATIONS:  Not surprisingly, the markets didn’t react too well to the manufacturing contraction number.  It has been quite clear that the manufacturing sector globally has been hurt badly by the trade war.  J.P. Morgan’s Global Manufacturing Index was negative for the fourth consecutive month.  The U.S. decline joins drops in the Eurozone and Japan.  However, all these negative numbers don’t indicate the U.S. or the world is now in a recession.  Indeed, the ISM index has to fall another six points before it indicates the U.S. economy could be shrinking.  It does show that that third quarter growth is likely to be in the 2%, which is pretty much the consensus forecast.  Since that is roughly trend growth, I am not ready to say a recession is baked in the cake.  Manufacturing can decline for a while without the economy flat lining.  But that means the consumer has to pick up the pace, as businesses are not going to invest facing the uncertainties created by the trade war.  And that make the labor market data even more important. Given the weak ISM employment index, it will be interesting to see what the manufacturing number is in Friday’s August jobs report.  I would not be surprised if the sector shed workers and that could help make the report a pretty mediocre one.  The strong labor market has been the chief reason consumer confidence and spending has been solid.Take that away and then I start worrying about a recession.  A disappointing payroll gain could put even more pressure on the Fed to cut rates again soon.  Unfortunately for the Fed, lower rates are likely to do little since they are falling because of recession worries.  Businesses are not likely to invest heavily if they don’t think the economy will hold up.  And if households start fearing a recession, will they actually start taking on more debt?  To those who say the Fed can save us, I need only remind them that the context within which the Fed reduces rates matters, not just the level – and the context is not positive.