The RSM Manufacturing Outlook Index is reporting a remarkable rebound of sentiment in the U.S. manufacturing industry. But while the worst might be behind us, the index remains slightly negative at nearly 0.3 standard deviations below normal conditions, which suggests that a national recovery has yet to materialize. Moreover, damage to the manufacturing sector wrought by pullbacks and shutdowns of business across the economy due to an intensification of the pandemic will appear in the July sentiment and survey data, thus we do urge caution in interpreting the data going forward.
This response of manufacturers to the surveys of six regional Federal Reserve banks (on which the RSM index is based) mimics the widely followed Institute for Supply Management’s national survey of manufacturing purchasing managers, which is set to be released on Wednesday, July 1. The consensus forecast for the ISM index – which is centered on 50 – is for a rebound to 49.5, indicating a continuation of the contraction, but barely so. We show both the RSM and ISM indices in the figure below.
Of the five regional central banks reporting surveys for June, manufacturing sentiment was positive in the Dallas and Philadelphia regions. Manufacturing conditions showed improvement (compared to the previous two months) in all other regions, but were tepid or not yet positive. Rather, the composite RSM index suggests the outlook for manufacturing sales will remain on its downward trajectory on a national basis, which we show in the following figure, though there will clearly be regional differences.
We cannot overemphasize the outsized role of manufacturing in the general health of the overall economy. As we show in the figure below, the growth of manufacturing sales has historically either presaged the start of an economic downturn or has dropped precipitously after an existential shock spins the economy into recession (e.g., the oil embargo shocks of the 1970s oil and the financial shocks of the early 1980s and 2008).
This year’s combined supply and demand shock caused by the coronavirus appears to have had much the same effect on manufacturing sales, though survey participants now appear to be pricing in a much quicker response and recovery from that shock. While welcome, it’s unclear whether that optimism is warranted quite yet. After all, a vaccine has yet to be found and tested, and even then it will take time and a conscientious effort to produce and disseminate the vaccine worldwide. The economic powerhouses of the world are slowing down or are in recession, and the knock-on effects of rising U.S. unemployment, loss of income and security, and the lack of demand have yet to filter through the global supply chain.
So after three months of an economic shutdown, what are the policy recommendations? Congress uncharacteristically passed massive income support in the blink of an eye, but what will happen to consumer spending once the emergency unemployment benefits expire in mid-July? House members will undoubtedly face Tea Party-type criticism should they continue subsidizing the unemployed, which is probably why there was such a rush to reopen local economies and get the 47+ million newly unemployed people off state ledgers. And the Senate is unlikely to allow expansion of the social safety net, for fear of antagonizing their means of support.
We would venture a guess that help for the manufacturing sector is unlikely to come either from a rapid increase in demand from our international trading partners or from government support until after the November election. If support were to come from this Senate, consider that its playbook has been limited to tax cuts, which would be as ineffective in increasing consumer demand at a time of rationing and caution as the 2017 tax cuts were in increasing business investment.
So let’s take lead of J.P. Morgan who – before there was a Federal Reserve Bank – partnered up with his associates to create a private central bank to be the lender of last resort and to smooth the ups and downs that plagued the financial sector and the economy early in the 20th century.
Since we admire public-private endeavors, corporate America could take it upon itself to create industries that benefit the public well-being, creating domestic companies to manufacture health care products like surgical masks and gloves, ventilators and other necessities to fight this virus and the next. The return for companies would be good-will advertising and tax breaks.
A coalition of homebuilders could construct hospitals in underserved rural areas, thus creating the means for construction workers to build their own home and to accumulate family wealth. A coalition of wireless companies and tech companies could set up domestic manufacturing of equipment to extend internet access to those same rural areas, thus creating a customer base for tech products. And finally, corporations could each adopt or create a school that would guarantee access to equal levels of education, thus creating the knowledge base for the next generation of advanced manufacturing.
Guide to the RSM Manufacturing Outlook Index
Six of the regional Federal Reserve banks conduct monthly surveys of manufacturing activity and sentiment. We’ve aggregated those surveys into the composite RSM Manufacturing Outlook Index that anticipates the direction of national manufacturing activity.
The RSM Manufacturing Outlook Index is measured in Z-scores, which are the number of standard deviations from normal levels. The bank surveys are reported as diffusion indices, which vary from bank to bank (but are generally measured as positive responses minus negative responses). The survey results are standardized relative to average sentiment during the period from 1994-2008, just prior to the Great Recession.
The table below shows that each of regional surveys has dropped in value since the peaks reached during the 2017-2020 pre-crisis period.
Regional surveys over time
Time series for the individual surveys are included below, with the regional diffusion indices shown relative to the growth of national manufacturing sales.
Each of the surveys shows (1) a decline in manufacturing from 2017 through the present that coincides with a deceleration in manufacturing sales growth and (2) an uptick in manufacturing sales at the end of 2019 and into January and February 2020, and (3) which was followed by the sharp drop in the surveys reported in March-May due to the U.S. coronavirus outbreak. Note that the Chicago survey is updated through April.
