Taking stock of recession indicators

The U.S. Institute for Supply Management’s (ISM) manufacturing index dropped from 49.1 in August to 47.8 in September. A score below 50 is regarded as a possible recession indicator, and Montreal-based National Bank noted in a weekly report that the decline signals “the worst deterioration in factory conditions in 10 years. The last time the index sank that low outside of a recession was in 2003.”

However, despite the trade war “wreaking havoc” on factories, National Bank said there are reasons to not be overly alarmed by the September ISM number. The report pointed to Markit’s purchasing manager’s index, which showed that U.S. manufacturing grew last month at its fastest pace in five years. The divergence can be explained partly by panel size and the fact that the ISM, which covers more large companies, would have been more affected by the General Motors strike, the report said.

“However, even if we accept that manufacturing is in as bad a state of affairs as the ISM suggests, it does not necessarily mean the U.S. economy as a whole is in recession,” National Bank said.

Economists regularly point to the diminishing significance of the ISM as an economic gauge, given the expanded role of services compared to manufacturing in modern economies. However, ISM’s non-manufacturing index fell to 52.6 in September, its lowest level in three years.

Benjamin Tal, deputy chief economist at CIBC Capital Markets, said in a weekly report Friday that the market panic this week over the ISM manufacturing index was overstated. The index has fallen below 50 on 13 occasions since the 1980s, he wrote, only five of which were during a recessionary period.

The non-manufacturing ISM, however, is cause for more concern, he said, as it has only fallen below 50 when there’s been a recession.

“We are not there yet, but the pace of the current softening trajectory is notably faster than seen in any other period of non-recessionary slowing,” he wrote.

Politics and the economy

Despite the negative impacts, there may be some logic behind the chaos of President Donald Trump’s trade war, Tal said. He called the president’s strategy “triple dipping.”

The uncertainty the conflict has created in the global economy is influencing the Federal Reserve’s decision to cut interest rates, which it has done twice since the end of July. Tal called the president’s tweeting about monetary policy “personal reinsurance” in case of recession, allowing him to blame the central bank for not cutting enough.

The trade uncertainty also allows Trump to spend to grow the economy, thus adding fiscal stimulus to the Fed’s monetary push, Tal wrote.

Finally, the conflict creates the space for the president to benefit from its resolution in “a market pleasing trade agreement with China … just in time for the 2020 elections.” An agreement doesn’t need to be comprehensive to lead to a “relief rally” and boost short-term growth.

“If that’s the case, the administration will have to demonstrate a significant move on the China file soon. Otherwise the wolf will turn out to be real,” Tal said.

In a speech in Toronto this week, Signum Global Advisors founder and chairman Charles Myers said political pressure from impeachment proceedings could also contribute to a positive outcome on trade, as the president will need good news from markets and could find it in a “mini-deal.”

“The markets don’t care, in the end, if we get to a deeply structural deal with China,” which China won’t do anyway, Myers said. “What the markets want is a de-escalation, and I think we’re going to get that.”

Read the full reports from CIBC and from National Bank.