Why did US recession fears rise again and scare the stock market on Tuesday?

Written by on October 2, 2019

The American consumer has been propping up the U.S. economy, but fears deepened Tuesday that the troubled U.S. manufacturing sector could ultimately drag it down.

Factory activity shrank at the fastest pace in a decade last month amid the U.S.-China trade war and slowing global growth, driving stocks lower and reviving recession fears.

Those forces also led the World Trade Organization on Tuesday to sharply lower its forecast for global trade growth this year to 1.2%. That’s down from its 2.6% estimate in April and a gain of 3% last year.

A closely watched index of factory activity dropped to 47.8 in September from 49.1 the prior month, according to the Institute for Supply Management. That’s below the reading of 50 that economists expected and reflects a contraction in the sector for the second straight month. An index above 50 means expansion while below means contraction.

The index clocked in at the lowest level since June 2009, just after the Great Recession ended.

Manufacturing makes up only about 12% of the economy. But troubles in the sector can have an outsize effect on the economy by damping business confidence and curtailing factory payrolls, which in turn hurts consumer spending, says economist Gregory Daco of Oxford Economics.

Presidents Donald Trump and Xi Jinping have hit the reset button in trade talks between the world’s two biggest economies, at least delaying an escalation in tension that had financial markets on edge and cast a cloud over the global economy. (June 29) AP

“This does increase the likelihood of entering a more pronounced slowdown,” Daco says. Oxford reckons the odds of a recession are 40% next year but many economists are predicting a downturn. Solid consumer spending, which makes up 70% of economic activity, had somewhat eased fears of a slump but the deepening skid in manufacturing is stoking those concerns anew.

Measures of production and employment shrank more sharply than in August while new export orders fell at a faster pace for a third straight month. An index of overall orders – which typically foreshadows future production — rose slightly but remained in contraction territory.

“Global trade remains the most significant issue, as demonstrated by the contraction in new export orders that began in July,” says Timothy Fiore, chair of ISM’s manufacturing business survey committee.

The Dow Jones industrial average tumbled about 300 points, or 1.1%, to 26,636 in midday trading.

The dim manufacturing picture can be pinned mostly on sluggish growth overseas and the Trump Administration’s trade war with China, says Wells Fargo Senior Economist Sarah House. Trump has slapped tariffs on most imports from China, increasing costs for U.S. businesses and consumers. China has responded in kind, crimping U.S. exports to that country.

President Trump, however, blamed the weakening manufacturing outlook on one of his favorite targets – the Federal Reserve.  

“As I predicted, Jay Powell and the Federal Reserve have allowed the Dollar to get so strong, especially relative to ALL other currencies, that our manufacturers are being negatively affected,” Trump tweeted Tuesday morning.  “Fed Rate too high. They are their own worst enemies, they don’t have a clue.  Pathetic!”

A strong dollar makes American exports more expensive for overseas buyers, hampering American companies. It also means lower profits when foreign sales are converted back to greenbacks.

House agrees the muscular dollar can partly be traced to the Fed, which has raised its key interest rate nine times since late 2015 to head off a spike in inflation as the tax cuts and spending increases spearheaded by Trump juiced the economy. The Fed has cut rates twice since late July but foreign central banks are slashing rates more aggressively. Higher U.S. interest rates draw foreign investments, bolstering the dollar.

But the main reason the greenback has strengthened is that the U.S. economy has performed better than other countries, House says. And while the robust dollar is contributing to the manufacturing slowdown, the main factors are the listless global economy and trade war, she says.

U.S. and Chinese officials are set to resume negotiations later this month, with many analysts expecting a modest agreement that increases American agricultural exports to China while removing some tariffs. House, however, doesn’t expect an upturn in manufacturing until the two countries reach a broader deal that addresses thorny issues, such as China’s theft of U.S. intellectual property.

Some economists are more upbeat. Paul Ashworth of Capital Economics partly blames manufacturing’s doldrums on the General Motors strike that began in mid-September.

“When the strike ends, we would expect the manufacturing sector surveys to rebound too,” he wrote in a note to clients.

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