US manufacturing is not a recession red flag

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Stop worrying so much about manufacturing surveys

The S&P 500 fell by more than 2 per cent yesterday. The Financial Times story (and indeed every story) on the sell-off linked the decline to weak survey data from the manufacturing sector, which “added to investor concerns about an economic slowdown”. 

The survey-based ISM Manufacturing index for August, at 47.2, was barely improved from its dreary July level. The index’s new orders component, thought to be a leading indicator, fell almost three points, to 44.6. Remember (who would blame you for blocking it out?) that the poor July reading was the initial tremor that, when combined with a bad jobs report, became the market mini-quake of a month ago. 

So this seems like a good moment to ask how much we should worry about weak manufacturing ISM readings. And the answer is: not much. 

A few obvious points to start. First, the August number is not really news. The July and August ISM readings are not that much worse than the numbers from the past couple of years. Yes, the new orders number is a multiyear low, but it’s just one month:

Next, it is not obvious that the market sell-off had all that much to do with the manufacturing report. The most notable decliner yesterday was Nvidia, off almost 10 per cent. Nvidia is not a manufacturer, and is not particularly sensitive to the cyclical trends that affect manufacturers. Broadening the point, the persistently soft signal from the ISM survey has not been picked up by the stock market: industrial stocks have done just fine in the past couple of years. 

In theory, we should care about a manufacturing survey — despite manufacturing being a bit more than a tenth of US GDP, and an even smaller share of employment — because manufacturing can be a leading indicator of demand in other sectors. “If there is no appetite for manufactured goods from services, retail, mining or construction, that tells you something,” says Skanda Amarnath of Employ America. That said, Amarnath also points out that US manufacturers serve global customers, so the ISMs may reflect weak global, rather than US demand. And uncertainty about the rate cycle and the presidential election may be shifting demand to the future, rather than destroying it. 

If the weak manufacturing ISM reading reflected low investment level by domestic customers, we would expect to see that in the GDP data on investment. But real investment growth has only fallen a bit (and investment in equipment is rising): 

Matthew Martin of Oxford Economics generalises the point: “soft” indicators of sentiment such as surveys and “hard” indicators of production have come apart in manufacturing. This should not come as a surprise to us at a moment when consumer sentiment (lousy) and consumption (just fine, thanks) are not tracking each other either. He thinks manufacturing is set to recover. Inventory levels are low and will have to rise at some point; lower interest rates should support investment; getting the election over with one way or the other will help confidence; and subsidies and other Biden administration supports for domestic manufacturing continue. 

Housing supply

Housing in America is punishingly expensive, and the presidential candidates have noticed. Kamala Harris has promised to increase housing supply by 3mn units. Donald Trump has pledged to bring down prices and to “protect America’s suburbs”. 

If the next president is lucky, falling interest rates will loosen the market. But a real fix requires new supply — and the supply side of the US housing market is mostly governed locally, not federally. Local zoning laws tend to focus on maintaining property values and a neighbourhood’s “feeling”, and thus often limit new buildings through lengthy approval processes or restrictive policies.

So how can the federal government increase supply? Experts identify four policy routes:

• Financial incentives to build new units. This has been done through block grants that help states to construct new public housing units, and through the Low-Income Housing Tax Credit (LIHTC), which rewards builders of affordable homes. The Harris campaign has proposed a tax incentive for developers that make affordable starter homes. The Trump campaign has made no such promises. But, again, developers receiving stimulus are governed by local law.

• Influence local zoning. The federal government can incentivise local governments to change their zoning laws. Just last year, the Biden administration launched the Pathways to Removing Obstacles to Housing programme, which rewards jurisdictions up to $10mn for removing laws that limit new building. The Biden administration and several bills in Congress have also tried to encourage the legalisation of new, cheaper types of housing. This is mostly uncharted territory, though. From Sara Bronin at Cornell University, who runs the National Zoning Atlas:

I would argue that we don’t know enough about zoning to be precise about those incentives . . . The current federal programmes tend to have very general outcomes; they don’t prescribe many specific actions that local governments must make.

And reforming zoning laws is hard even when change is initiated locally. From Kate Nelischer at the University of Southern California: 

Changing local zoning laws requires a lot of professional planners, and long processes of community consultation that can be contentious . . . It is not an easy challenge to solve, and there are a lot of [additional] complexities when the federal government works with local and state authorities.

• Incentivise conversions and rehabilitations. The government could incentivise the rehabilitations of old houses not currently in use. The Harris-Walz campaign endorsed the Neighborhood Homes Tax Credit, a Senate proposal to give tax credits for rehabilitations.

  The federal government could also incentivise the conversion of empty commercial buildings. The Biden administration put conversions in its action plan, but there is no federal tax incentive on the books — but passing one may be viewed as a bailout for real estate investors, and thus politically sensitive.

• Reward selling. Existing home sales make up the majority of the housing market, and those sales have been frozen by the current fiscal situation. Twenty per cent of sold homes are actually net additive to the market, meaning that the owner did not buy or rent a new home after selling, according to Rick Palacios at John Burns Consulting — either because it was a vacation home, an investment or they moved in with family afterwards. Revising current capital gains tax laws could incentivise owners of multiple properties to relinquish the excess supply to the market. Giving a tax break to families that own multiple homes could be politically tricky, though. 

In short: there are things the federal government can do, but local zoning remains the key determinant, and the politics are tricky. Any change emanating from Washington will be painfully slow. 

(Reiter)

One good read

Beijing in Albany.

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