KEY DATA: ISM (Manufacturing): -0.5 pt.; Orders: +0.8 pt.; Employment: -2.8 pts./ Construction: -1.3%; Private: -0.4%/ Notices: 38,845/ Claims: +8,000
IN A NUTSHELL: “The manufacturing sector is not likely to do much until the trade issues are behind us.”
WHAT IT MEANS: If you believe the Fed and Mr. Powell in particular, it is all about trade. Trade wars are causing uncertainty, slowing world growth, U.S. business investment and exports and restraining manufacturing activity. And there is little doubt that is the case. In July, we saw that the industrial portion of the economy continued to moderate. The Institute for Supply Management’s Manufacturing index eased to its lowest in three years. Production and hiring increased significantly more slowly and order books thinned at a more rapid pace. None of those are good signs and the modest increase in jobs points minimal help from manufacturing in tomorrow’s July employment report. A similar measure, the IHS Markit Manufacturing Purchasing Managers’ Index, hit its lowest level in nearly a decade, so it does appear that manufacturing conditions have weakened significantly this year.
Adding to the economy’s woes is the slowdown in construction, which declined sharply in June. Most of that came from a large drop in government spending on education, highways and health care. I guess we don’t need new schools, roads or hospitals. But this report was not totally negative as private sector commercial and health care construction rose. Still, commercial construction has not been great this year and there is little reason to expect that to change.
As for the labor market data, the numbers did little to change the perception that conditions remain tight. Challenger, Gray and Christmas reported that layoff notices continue to grow rapidly. The weakest sector is industrial goods, consistent with the softening of the manufacturing sector. The rise in unemployment claims last week only moves us back to more normal, but extraordinarily low levels.
MARKETS AND FED POLICY IMPLICATIONS: What will Mr. Powell and his band of monetary policy makers do next? You tell me and we both know. The economy is still expanding decently but the trade war issues are not going away. With China showing it can be just as intransigent as Trump, don’t look for much to happen anytime soon. The Chinese have decided to target agriculture and they are not buying our farm products. How long farmers will be willing to stay on government welfare I don’t know, but it cannot be for too much longer. A lot of what is going on has to do with politics not economics, so the Chinese decision to hurt the politically important farm sector has to be recognized as an important factor in the negotiations to create true change in the bilateral relationship. Consequently, if a trade agreement with China occurs, it is likely to be mostly puff and little pastry. But it would at least ease the uncertainty provide a short-term boost to growth. Until then, the expansion should continue to moderate but not falter. Chair Powell still claims the Fed is data dependent, which is hard to believe given the data didn’t support a rate cut. I just don’t know what he is looking at and what he characterizes as weak enough to cut again. If all he is worried about is world growth, he will probably get the data he needs to reduce rates again this year. If growth and inflation are the keys, I am not sure the numbers will be as supportive. And with the Fed clearly divided, forecasting what happens next has become a lot more uncertain, which is saying a lot given Mr. Powell’s penchant to change course on a dime.